A Project Report On Derivatives (Futures & Options)

Derivatives (Futures & Options)
A PROJECT REPORT ON
DERIVATIVES (FUTURES & OPTIONS)
BY
M.INDRA SHEKHAR
Hall Ticket no:- 0980-60-106
2006-2008
ST.PAULS P.G.COLLEGE
TURKAYAMJAL,
HYDERABAD
93
A PROJECT REPORT ON
DERIVATIVES (FUTURES & OPTIONS)
FOR
KOTAK SECURITIES PVT. LTD.
Submitted in partial fulfillment for the requirement of summer

internship for the award of Masters in Business Administration
BY
M.INDRA SHEKHAR
2006-2008
Under the guidance of
Mr.VISWANATH SARMA
Faculty in Finance
ST.PAULS P.G.COLLEGE
TURKAYAMJAL,
HYDERABAD
93
ACKNOWLEDGEMENT
I express my profound gratitude to the team at KOTAK
SECURITIES, Hyderabad. For providing a congenial and
competitive work environment, which a great learning
experience.
I am also deeply indebted to MUSTAFA SHAIKH Branch
Manager of Kotak Securities for providing and Opportunity to do
my Project.
I am also expressing my Sincere thanks to my Internal Project
Guide Mr.VISWANATH SARMA, for his valuable suggestions,
and constant encouragement at every step of the project.
93
CERTIFICATE
This is to certify that the project Report on
DERIVATIVES (FUTURES & OPTIONS) submitted in
partial fulfillment for the award of MBA programme of
Department of Business Management, O.U.
Hyderabad
was carried out byM.INDRA SHEKHAR under my

guidance. This has not been submitted to any other
University or Institution for the awards of any
degree/diploma/certificate.
Name and address of the Guide
Signature of the Guide
93
TABLE OF CONTENTS
CHAPTERS
Chapter-I
Chapter-II
DESCRIPTION
Introducing to the topic
Definition
Objectives
Limitations
Review of Literature
About stock
exchange
( BSC and
Reliance)
Growth
Financial risk
Company Profile and
Company Products
Chapter-III
Chapter-IV
Analysis
Chapter-V
Findings, Conclusions,
Glossary& Methodology
Chapter-VI
Bibliography
PAGE NO.
13
25 - 50
51-61
62-100
101-105
106
93
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The Kotak Mahindra Group

Kotak Mahindra is one of India's leading financial institutions, offering
complete financial solutions that encompass every sphere of life. From
commercial banking, to stock broking, to mutual funds, to life
insurance, to investment banking, the group caters to the financial
needs of individuals and corporate.
The group has a net worth of around Rs. 3,100 crore, employs around
9,600 people in its various businesses and has a distribution network of
branches, franchisees, representative offices and satellite offices across
300 cities and towns in India and offices in New York, London, Dubai
and Mauritius. The Group services around 2.2 million customer
accounts.
Group Management
Mr. Uday Kotak
Mr. Shivaji Dam
Mr. C. Jayaram
Mr. Dipak Gupta
Executive Vice Chairman & Managing Director
The Kotak Mahindra Group was born in 1985 as Kotak Capital

Management Finance Limited. This company was promoted by Uday
Kotak, Sidney A. A. Pinto and Kotak & Company. Industrialists Harish
Mahindra and Anand Mahindra took a stake in 1986, and that's when
the company changed its name to Kotak Mahindra Finance Limited.
Since then it's been a steady and confident journey to growth and
success.
1986
1987
1990
1991
Kotak Mahindra Finance Limited starts the activity of Bill Discounting

Kotak Mahindra Finance Limited enters the Lease and Hire Purchase
market
The Auto Finance division is started
The Investment Banking Division is started. Takes over FICOM, one of
India's largest financial retail marketing networks
93
1992
1995
1996
1998
2000
2001
2003
2004
2005
2006
Enters the Funds Syndication sector

Brokerage and Distribution businesses incorporated into a separate
company - Kotak Securities. Investment Banking division incorporated
into a separate company - Kotak Mahindra Capital Company
The Auto Finance Business is hived off into a separate company - Kotak
Mahindra Prime Limited (formerly known as Kotak Mahindra Primus
Limited). Kotak Mahindra takes a significant stake in Ford Credit Kotak
Mahindra Limited, for financing Ford vehicles. The launch of Matrix
Information Services Limited marks the Group's entry into information
distribution.
Enters the mutual fund market with the launch of Kotak Mahindra Asset
Management Company.
Kotak Mahindra ties up with Old Mutual plc. For the Life Insurance
business.
Kotak Securities launches its on-line broking site (now
www.kotaksecurities.com). Commencement of private equity activity
through setting up of Kotak Mahindra Venture Capital Fund.
Matrix sold to Friday Corporation
Launches Insurance Services
Kotak Mahindra Finance Ltd. converts to a commercial bank - the first
Indian company to do so.
Launches India Growth Fund, a private equity fund.
Kotak Group realigns joint venture in Ford Credit; Buys Kotak Mahindra
Prime (formerly known as Kotak Mahindra Primus Limited) and sells
Ford credit Kotak Mahindra.
Launches a real estate fund
Bought the 25% stake held by Goldman Sachs in Kotak Mahindra Capital
Company and Kotak Securities
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COMPANY PRODUCTS
Kotak Mahindra Bank
At Kotak Mahindra Bank, we address the entire spectrum of financial
needs for individuals and corporate. We have the products, the
experience, the infrastructure and most importantly the commitment to
deliver pragmatic, end-to-end solutions that really work.
Kotak Mahindra Old Mutual Life Insurance is a 76:24 joint venture
between Kotak Mahindra Bank Ltd. and Old Mutual plc. Kotak
Mahindra Old Mutual Life Insurance is one of the fastest growing
insurance companies in India and has shown remarkable growth since
its
inception
in
2001.
Old Mutual, a company with 160 years experience in life insurance, is
an international financial services group listed on the London Stock
Exchange and included in the FTSE 100 list of companies, with assets
under management worth $ 400 Billion as on 30th June, 2006. For
customers, this joint venture translates into a company that combines
international expertise with the understanding of the local market
Car Finance
Kotak Mahindra Prime Limited (KMPL) is a subsidiary of Kotak
Mahindra Bank Limited formed to finance all passenger vehicles. The
company is dedicated to financing and supporting automotive and
automotive related manufacturers, dealers and retail customers.The
Company offers car financing in the form of loans for the entire range
of passenger cars and multi utility vehicles. The Company also offers
Inventory funding to car dealers and has entered into strategic
arrangement with various car manufacturers in India for being their
93
preferred financier
Kotak Securities Ltd.
Kotak Securities Ltd. is India's leading stock broking house with a
market share of around 8.5 % as on 31st March. Kotak Securities Ltd.
has been the largest in IPO distribution.
The accolades that Kotak Securities has been graced with include:
Prime Ranking Award (2003-04) - Largest Distributor of IPO's
Finance Asia Award (2004) - India's best Equity House
Finance Asia Award (2005)-Best Broker in India
Euro money Award (2005)-Best Equities House in India
Finance Asia Award (2006) - Best Broker in India
Euro money Award (2006) - Best Provider of Portfolio

Management: Equities
Kotak Securities Ltd - Institutional Equities

Kotak Securities, a subsidiary of Kotak Mahindra Bank, is the stockbroking and distribution arm of the Kotak Mahindra Group. The
institutional business division primarily covers secondary market
broking. It caters to the needs of foreign and Indian institutional
investors in Indian equities (both local shares and GDRs). The division
also has a comprehensive research cell with sect oral analysts covering
all the major areas of the Indian economy.
Kotak Mahindra Capital Company (KMCC)
Kotak Mahindra Capital Company (KMCC) helps leading Indian
corporations, banks, financial institutions and Government Companys
access domestic and international capital markets.
It has been a leader in the capital markets, having consistently led the
league tables for lead management in the past five years, leading 16 of
the 20 largest Indian offerings between fiscal 2000 and 2006.
KMCC has the most current understanding of investor appetite, having
been the leading book runner/lead manager in public equity offerings
in the period FY 2002-06
Kotak Mahindra International
93
Kotak has wholly-owned subsidiaries with offices in Mauritius,

London, Dubai and New York. These subsidiaries specialize in
providing services to overseas investors seeking to invest into India.
Investors can access the asset management capability of the
international subsidiaries through funds domiciled in Mauritius.
The international subsidiaries offer brokerage and asset management
services to institutions and high net worth individuals based outside
India through their range of offshore India funds, as well as through
specific advisory and discretionary investment management mandates
from institutional investors. The International subsidiaries also provide
lead management and underwriting services in conjunction with Kotak
Mahindra Capital Company with respect to the issuances of domestic
Indian securities in the international marketplace.
Offerings from the International subsidiaries
Kotak Indian Growth Fund The fund aims to achieve capital
appreciation by being invested in shares and equity-linked instruments
of Indian companies.
Kotak Indian Mid-Cap Fund The fund aims to achieve capital
appreciation by being primarily invested in the shares and equity
linked instruments of mid-capitalization companies in India.
Kotak Indian Life Sciences Fund The fund aims to achieve capital
appreciation by being invested in shares and equity-linked instruments
of Indian companies in the life sciences business.
Kotak Indian Shariah Fund Kotak Indian Shariah Fund, an Indian
Equity fund which endeavors to achieve capital appreciation by being
invested in the shares and equity-linked instruments of companies
which are Shariah compliant
Indian Equity Fund of Funds the Portfolio endeavors to achieve capital
appreciation by being substantially invested in the shares or units of
Mutual Funds schemes that are either:
i. Equity schemes investing predominantly in Indian equities.
ii. Equity fund of funds schemes investing predominantly in units
of other Mutual Fund schemes that invest mainly in Indian
equities.
Kotak Liquid Fund the Kotak Liquid Fund endeavors to invest
predominantly in Debt and Money Market instruments of short
93
maturity (less than 180 days) and other funds which invest in such
securities across geographies and currencies as applicable under the
prevailing laws. The fund may also invest in bank deposits.
Focused India Portfolio Focused India Portfolio seeks to capture the
pan-India story through specific bottom up investments across sectors
and market capitalizations
The Fund
Kotak Realty Fund, established in May 2005, is one of India's first
private equity funds with a focus on real estate and real estate intensive
businesses. Kotak Realty Fund operates as a venture capital fund,
under the SEBI Venture Capital Fund Regulations, 1996 in India. The
fund's corpus has been contributed by leading banks, domestic
corporates, family offices and high net worth individuals. The fund is
closed ended and has a life of seven years.
Investment Formats
The fund would seek equity investments in development projects,
enterprise level investments in real estate operating companies, and in
real estate intensive businesses not limited to hotels, healthcare,
retailing, education and property management. Further, the fund would
also be investing in non-performing loans with underlying property
collateral.
Asset Class
The fund would invest in all the main property asset classes such as
residential (townships, luxury residential, low cost housing, golf
communities), hospitality (hotels and serviced apartments), office (core
and business parks), shopping centres and alternative asset classes such
as logistics and warehousing.
Geographical Locations
In order to achieve geographical diversity, the fund would invest in not
just the Tier I cities such as Mumbai, NCR and Bangalore but also in
Tier II cities such as Pune, Calcutta, Hyderabad and Chennai) and
93
other Tier III cities, examples of which are Nagpur, Coimbotore,

Mysore and Ludhiana)
The Fund Manager believes that through diversification in
geographies, asset class and investment formats, the Fund should be
well positioned to achieve superior risk adjusted returns.
Fund Management Team
Kotak Realty Fund is managed by its investment team located in
Mumbai, India and supported by an organization in which thought
leadership, contrarian play, due diligence, communication and
collaborative partnerships take precedence. The Fund has a core team
of professionals dedicated to sourcing, analyzing, executing and
managing the investments. This unique team brings together profiles
combining real estate corporate finance advisory, investment banking,
venture capital, infrastructure development and finance, and REITS
valuation experience.
Kotak Mahindra Asset Management Company Limited
(KMAMC)
Kotak Mahindra Asset Management Company Limited (KMAMC), a
wholly owned subsidiary of KMBL, is the Asset Manager for Kotak
Mahindra Mutual Fund (KMMF). KMAMC started operations in
December 1998 and has over 4 Lac investors in various schemes.
KMMF offers schemes catering to investors with varying risk - return
profiles and was the first fund house in the country to launch a
dedicated gilt scheme investing only in government securities.
We are sponsored by Kotak Mahindra Bank Limited, one of India's
fastest growing banks, with a pedigree of over twenty years in the
Indian Financial Markets. Kotak Mahindra Asset Management Co.
Ltd., a wholly owned subsidiary of the bank, is our Investment
Manager.
We made a humble beginning in the Mutual Fund space with the
launch of our first scheme in December, 1998. Today we offer a
complete bouquet of products and services suiting the diverse and
varying needs and risk-return profiles of our investors.
We are committed to offering innovative investment solutions and
world-class services and conveniences to facilitate wealth creation for
our investors.
93
ST
As on DEC 31 , 2007
AUM - Rs. 12125.15 Crores
No. of Investors - 5.05 Lakhs
We are sponsored by Kotak Mahindra Bank Limited, one of

India's fastest growing banks, with a pedigree of over twenty
years in the Indian Financial Markets. Kotak Mahindra Asset
Management Co. Ltd., a wholly owned subsidiary of the bank,
is our Investment Manager.
We made a humble beginning in the Mutual Fund space with
the launch of our first scheme in December, 1998. Today we
offer a complete bouquet of products and services suiting the
diverse and varying needs and risk-return profiles of our
investors.
We are committed to offering innovative investment solutions
and world-class services and conveniences to facilitate wealth
creation for our investors.
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Scope of the Study

Objectives
Limitations
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INTRODUCTION OF DERIVATIVES
The emergence of the market for derivative products, most notably
forwards, futures and options, can be traced back to the willingness of
risk-averse economic agents to guard themselves against uncertainties
arising out of fluctuations in asset prices. By their very nature, the
financial markets are marked by a very high degree of volatility.
Through the use of derivative products, it is possible to partially or
fully transfer price risks by locking-in asset Prices. As instruments of
risk management, these generally do not influence the Fluctuations in
the underlying asset prices. However, by locking-in asset prices,
Derivative products minimize the impact of fluctuations in asset prices
on the Profitability and cash flow situation of risk-averse investors.
Derivatives are risk management instruments, which derive their
value from an underlying asset. The underlying asset can be bullion,
index, share, bonds, Currency, interest, etc., Banks, Securities firms,
companies and investors to hedge risks, to gain access to cheaper
money and to make profit, use derivatives. Derivatives are likely to
grow even at a faster rate in future.
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DEFINITION OF DERIVATIVES
Derivative is a product whose value is derived from the value of an
underlying asset in a contractual manner. The underlying asset can be
equity, Forex, commodity or any other asset.
Securities Contract ( regulation) Act, 1956 (SC(R) A)defines
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
prices, of underlying securities.
HISTORY OF DERIVATIVES MARKETS
Early forward contracts in the US addressed merchants concerns
about ensuring that there were buyers and sellers for commodities.
However credit risk remained a serious problem. To deal with this
problem, a group of Chicago; businessmen formed the Chicago Board
of Trade (CBOT) in 1848. The primary intention of the CBOT was to
provide a centralized location known In advance for buyers and sellers
to negotiate forward contracts. In 1865, the CBOT went one step
further and listed the first exchange traded derivatives Contract in
the US; these contracts were called futures contracts. In 1919,
Chicago Butter and Egg Board, a spin-off CBOT was reorganized to
allow futures trading. Its name was changed to Chicago Mercantile
Exchange (CME). The CBOT and the CME remain the two largest
organized futures exchanges, indeed the two largest financial
exchanges of any kind in the world today.
The first stock index futures contract was traded at Kansas City
Board of Trade. Currently the most popular stock index futures
contract in the world is based on S&P 500 index, traded on Chicago
93
Mercantile Exchange. During the Mid eighties, financial futures

became the most active derivative instruments Generating volumes
many times more than the commodity futures. Index futures, futures
on T-bills and Euro-Dollar futures are the three most popular Futures
contracts traded today. Other popular international exchanges that
trade derivatives are LIFFE in England, DTB in Germany, SGX in
Singapore, TIFFE in Japan, MATIF in France, Eurex etc.,
THE GROWTH OF DERIVATIVES MARKET
Over the last three decades, the derivatives markets have seen a
phenomenal growth. A large variety of derivative contracts have been
launched at exchanges across the world. Some of the factors driving
the growth of financial derivatives are:
Increased volatility in asset prices in financial markets,
Increased integration of national financial markets with
the international markets,
Marked improvement in communication facilities and
sharp decline in their costs,
Development of more sophisticated risk management
tools, providing economic agents a wider choice of risk
management strategies, and
Innovations in the derivatives markets, which optimally
combine the risks and returns over a large number of
financial assets leading to higher returns, reduced risk as
well as transactions costs as compared to individual
financial assets.
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DERIVATIVE PRODUCTS (TYPES)

The following are the various types of derivatives. They are:
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.
Warrants:
Options generally have lives of upto 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:
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The acronym LEAPS means Long-Term Equity Anticipation

Securities. These are options having a maturity of upto three years.
Baskets:
Basket options are options on portfolio of underlying assets. The
underlying asset is usually a moving average of a basket of assets.
Equity index options are a form of basket options.
Swaps:
Swaps are private agreement 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:
The 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 cashflows in one direction being in a different currency than
those in the opposite direction.
Swaptions:
Swaptions are options to buy or sell a swap that will become operative
at the expiry of the options. Thus a swaption is an option on a forward
swap. Rather than have calls and puts, the swaptions market has
receiver swaptions and payer swaptions. A receiver swaption is an
option to receive fixed and pay floating. A payer swaption is an option
to pay fixed and received floating.
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PARTICIPANTS IN THE DERRIVATIVES MARKETS

The following three broad categories of participants:
HEDGERS:
Hedgers face risk associated with the price of an asset. They use
futures or options markets to reduce or eliminate this risk.
SPECULATORS:
Speculators wish to bet on future movements in the price of an asset.
Futures and options contracts can give them an extra leverage; that is,
they can increase both the potential gains and potential losses in a
speculative venture.
ARBITRAGEURS:
Arbitrageurs are in business to take advantage of a discrepancy
between prices in two different markets. If, for example they see the
futures prices 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.
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FUNCTIONS OF THE DERIVATIVES MARKET

In spite of the fear and criticism with which the derivative markets are
commonly looked at, these markets perform a number of economic
functions.
Price in an organized derivative markets reflect the
perception of market participants about the future and lead
the prices of underlying to the perceived future level. The
prices of derivatives converge with the prices of the
underlying at the
Expiration of the derivative contract. Thus derivatives help
in
discovery of future as well as current prices.
The derivative markets helps to transfer risks from those

who have them but may not like them to those who have an
appetite for them.
Derivative due to their inherent nature, are linked to the
underlying cash markets.
With the introduction of
derivatives, 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.
Speculative trades shift to a more controlled environment
of derivatives market.
In the absence of an organized
derivatives market, speculators trade in the underlying cash
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markets. Margining, monitoring and surveillance of the

activities of various participants become extremely difficult
in these kinds of mixed markets.
An important incidental benefit that flows from derivatives
trading is that it acts as a catalyst for new entrepreneurial
activity. The derivatives have a history of attracting many
bright,
creative,
Well-educated
entrepreneurial attitude.
people
with
an
They often energize others to
create new businesses, new products and new employment

opportunities, the benefit of which are immense.
SCOPE OF THE STUDY

The Study is limited to Derivatives with special reference to
futures and Option in the Indian context and the Inter-Connected
Stock Exchange have been Taken as a representative sample for the
study. The study cant be said as totally perfect. Any alteration may
come.
The study has only made a humble Attempt at evaluation
derivatives market only in India context. The study is not Based on the
international perspective of derivatives markets, which exists in
NASDAQ, CBOT etc.,
OBJECTIVES OF THE STUDY
To analyze the derivatives market in India.
To analyze the operations of futures and options.
To find the profit/loss position of futures buyer and
also
The option writer and option holder.
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Futures
Options
Trading
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NATURE OF THE PROBLEM

The turnover of the stock exchange has been tremendously
increasing form Last 10 years. The number of trades and the number of
investors, who are participating, have increased. The investors are
willing to reduce their risk, so they are seeking for the risk
management tools.
Prior to SEBI abolishing the BADLA system, the investors had this
system as a source of reducing the risk, as it has many problems like
no strong margining System, unclear expiration date and generating
counter party risk. In view of this problem SEBI abolished the
BADLA system.
After the abolition of the BADLA system, the investors are seeking
for a Hedging system, which could reduce their portfolio risk. SEBI
thought the Introduction of the derivatives trading, as a first step it has
set up a 24 member Committee under the chairmanship of
Dr.L.C.Gupta to develop the appropriate Framework for derivatives
trading in India, SEBI accepted the recommendation of the committee
on May 11, 1998 and approved the phase introduction of the
Derivatives trading beginning with stock index futures.
There are many investors who are willing to trade in the derivatives
segment, Because of its advantages like limited loss unlimited profit by
paying the small Premiums.
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THE DELOPMENT OF DERIVATIVES MARKET

Holding portfolios of Securities is associated with the risk of the
possibility that the investor may realize his returns, which would be
much lesser than what he expected to get. There are various factors,
which affect the returns:
1. Price or dividend (interest)
2. Some are internal to the firm like
Industrial policy
Management capabilities
Consumers preference
Labor strike, etc.,
These forces are to a large extent controllable and are termed as non
systematic risks. An investor can easily manage such non-systematic
by having a Well-diversified portfolio spread across the companies,
industries and groups so that a loss in one may easily be compensated
with a gain in other.
There are yet other of influence which are external to the firm,
cannot be controlled and affect large number of securities. They are
termed as systematic Risk. They are:
1. Economic
2. political
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3. Sociological changes are sources of systematic

risk
For instance, inflation, interest rate, etc. Their effect is to cause prices
if nearly All-individual stocks to move together in the same manner.
We therefore quite often find stock prices falling from time to time in
spite of companys earning rising and vice versa.
Rational Behind the development of derivatives market is to
manage this systematic risk, liquidity in the sense of being able to buy
and sell relatively large amounts quickly without substantial price
concession.
In debt market, a large position of the total risk of securities is
systematic. Debt instruments are also finite life securities with limited
marketability due to their small size relative to many common sticks.
Those factors favor for the purpose of both portfolio hedging and
speculation, the introduction of a derivatives securities that is on some
broader market rather than an individual security.
GLOBAL DERIVATIVES MARKET
The global financial centers such as Chicago, New York, Tokyo and
London dominate the trading in derivatives. Some of the worlds
leading exchanges for the exchange-traded derivatives are:
Chicago
Mercantile
exchange
(CME)
and
London International Financial Futures Exchange

(LIFFE)
( for currency & Interest rate
futures)
Philadelphia Stock Exchange(PSE),
London
Stock Exchange (LSE) & Chicago Board Options

Exchange (CBOE) ( for currency options)
93
New York Stock Exchange (NYSE) and London

Stock Exchange (LSE) (for equity derivatives)
Chicago
London
Mercantile
Metal
Exchange(CME)
Exchange
(LME)
and
(
for
Commodities)
These exchanges account for a large portion of the trading volume in
the respective derivatives segment.
NSEs DERIVATIVES MARKET
The derivatives trading on the NSE commenced with S&P CNX
Nifty index Futures on June 12, 2000. The trading in index options
commenced on June 4, 2001 and trading in options on individual
securities commenced on July 2, 2001 Single stock futures were
launched on November 9, 2001. Today, both in terms of volume and
turnover, NSE is the largest derivatives exchange in India. Currently,
the derivatives contracts have a maximum of 3-month expiration
cycles. Three contracts are available for trading, with 1 month, 2
month and 3 month expiry. A new contract is introduced on the next
trading day following of the near month contract.
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.
In this chapter we look at the broad regulatory framework for
derivatives trading and the requirement to become a member and an
authorized dealer of the F&O segment and the position limits as they
apply to various participants.
Regulation for derivatives trading:
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SEBI set up a 24-members committee under the Chairmanship

of Dr.L.C.GUPTA to develop the appropriate regulatory framework
for derivatives trading in India. On May 11, 1998 SEBI accepted the
recommendations of the committee and approved the phased
introduction of derivatives trading in India beginning with stock index
futures.
The provision in the SC(R) A and the regulatory framework
developed there under govern trading in securities. The amendment of
the SC(R) A to include derivatives within the ambit of securities in
the SC(R) A made trading in derivatives possible within the framework
of that Act.
Any Exchange fulfilling the eligibility criteria as
prescribed in the L.C.Gupta committee report can apply to
SEBI for grant of recognition under Section 4 of the
SC(R) A, 1956 to start trading derivatives. The derivatives
exchange/segment should have a separate governing
council and representation of trading/clearing members
shall be limited to maximum of 40% of the total members
of the governing council. The exchange would have to
regulate the sales practices of its members and would have
to obtain prior approval of SEBI before start of trading in
any derivative contract.
The Exchange should have minimum 50 members.
The members of an existing segment of the exchange
would not automatically become the members of
derivative segment. The members of the derivative
93
segment would need to fulfill the eligibility conditions as

laid down by the L.C.Gupta committee.
The clearing and settlement of derivatives trades would be
through a SEBI approved clearing corporation/house.
Clearing
corporations/houses
complying
with
the
eligibility as laid down by the committee have to apply to

SEBI for grant of approval.
Derivatives brokers/dealers and clearing members are
required to seek registration from SEBI. This is in addition
to their registration as brokers of existing stock exchanges.
The minimum net worth for clearing members of the
derivatives clearing corporation/house shall be Rs.300
Lakhs. The net worth of the member shall be computed
as follows :
Capital + Free reserves
Less non-allowable assets viz.,
Fixed assets
Pledged securities
Members card
Non-allowable
securities
securities)
Bad deliveries
Doubtful debts and advances
Prepaid expenses
Intangible assets
30 % marketable securities
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unlisted
The minimum contact value shall not
be less than Rs.2 Lakhs. Exchanges have to submit

details of the futures contract they propose to introduce.
The initial margin requirement, exposure limits linked to
capital adequacy and margin demands related to the risk
of loss on the position will be prescribed by SEBI /
Exchanged from time to time.
The
L.C.Gupta
committee
report
requires
strict
enforcement of Know your customer rule and requires

that every client shall be registered with the derivatives
broker. The members of the derivatives segment are also
required to make their clients aware of the risks involved
in derivatives trading by issuing to the clients the Risk
Disclosure and obtain a copy of the same duly signed by
the clients.
The trading members are required to have qualified
approved user and sales person who have passed a
certification programmed approved by SEBI.
93
ELIGIBILITY OF ANY STOCK TO ENTER IN DERIVATIVES

MARKET
Non Promoter holding ( free float capitalization ) not
less than Rs. 750 Crores from last 6 months
Daily Average Trading value not less than 5 Crores in
last 6 Months
At least 90% of Trading days in last 6 months
Non Promoter Holding at least 30%
BETA not more than 4 ( previous last 6 months )
93
93
Importance of Derivatives:
Derivatives are becoming increasingly important in world
markets as a tool for risk management. Derivatives instruments can be
used to minimize risk. Derivatives are used to separate risks and
transfer them to parties willing to bear these risks. The kind of hedging
that can be obtained by using derivatives is cheaper and more
convenient than what could be obtained by using cash instruments. It is
so because, when we use derivatives for hedging, actual delivery of the
underlying asset is not at all essential for settlement purposes.
More over, derivatives would not create any risk. They simply
manipulate the risks and transfer to those who are willing to bear these
risks. For example, Mr. A owns a bike. If does not take insurance, he
runs a big risk. Suppose he buys insurance [a derivative instrument on
the bike] he reduces his risk. Thus, having an insurance policy reduces
the risk of owing a bike. Similarly, hedging through derivatives
93
reduces the risk of owing a specified asset, which may be a share,

currency, etc.
INTRODUCTION OF FUTURES
Futures markets were designed to solve the problems that exist in
forward markets. A futures contract is an agreement between two
parties to buy or sell an asset at a certain time in the future at a certain
price.
But unlike forward contract, the futures contracts are
standardized and exchange traded. To facilitate liquidity in the futures

contract, the exchange specifies certain standard features of the
contract.
It is standardized contract with standard underlying
instrument, a standard quantity and quality of the underlying

instrument that can be delivered,
(Or which can be used for reference purpose in settlement) and a
standard timing of such settlement. A futures contract may be offset
prior to maturity by entering into an equal and opposite transaction.
More than 90% of futures transactions are offset this way.
The standardized items in a futures contract are:
Quantity of the underlying
Quality of the underlying
The date and the month of delivery
93
The units of price quotation and minimum

price change
Location of settlement
DEFINATION
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.
HISTORY OF FUTURES
Merton Miller, the 1990 Nobel Laureate had said that financial
futures represent the most significant financial innovation of the last
twenty years. The first exchange that traded financial derivatives was
launched in Chicago in the year 1972. A division of the Chicago
Mercantile Exchange, it was called the international monetary market
(IMM) and traded currency futures. The brain behind this was a man
called Leo Melamed, acknowledged as the father of financial futures
who was then the Chairman of the Chicago Mercantile Exchange.
Before IMM opened in 1972, the Chicago Mercantile Exchange sold
contracts whose value was counted in millions.
By 1990, the
underlying value of all contracts traded at the Chicago Mercantile

Exchange totaled 50 trillion dollars.
93
These currency futures paved the way for the successful marketing
of a dizzying array of similar products at the Chicago Mercantile
Exchange, the Chicago Board of Trade and the Chicago Board Options
Exchange. By the 1990s, these exchanges were trading futures and
options on everything from Asian and American stock indexes to
interest-rate swaps, and their success transformed Chicago almost
overnight into the risk-transfer capital of the world.
93
DISTINCTION BETWEEN FUTURES AND FORWARDS

CONTRACTS
Forward contracts are often confused with futures contracts. The
confusion is primarily because both serve essentially the same
economic functions of allocating risk in the presence of futures price
uncertainty. However futures are a significant improvement over the
forward contracts as they eliminate counterparty risk and offer more
liquidity. Comparison between two as follows:
FUTURES
FORWARDS
93
1.Trade
on
an 1. OTC in nature
Organized Exchange
2.Standardized
2.Customized contract
contract terms
terms
3. hence more liquid
3. hence less liquid
4. Requires margin
4. No margin payment
payment
5. Follows daily
5. Settlement
Settlement
at end of period
happens
Table 3.1
FEATURES OF FUTURES
Futures are highly standardized.
The contracting parties need not pay any down
payment.
Hedging of price risks.
They have secondary markets to.
TYPES OF FUTURES
93
On the basis of the underlying asset they derive, the futures are divided
into two types:
Stock Futures
Index Futures
PARTIES IN THE FUTURES CONTRACT

There are two parties in a futures contract, the buyers and the seller.
The buyer of the futures contract is one who is LONG on the futures
contract and the seller of the futures contract is who is SHORT on the
futures contract.
The pay-off for the buyers and the seller of the futures of the
contracts are as follows:
PAY-OFF FOR A BUYER OF FUTURES
93
PROFIT
LOSS
Figure 3.2
CASE 1:- The buyers bought the futures contract at (F); if the futures
Price Goes to E1 then the buyer gets the profit of (FP).
CASE 2:- The buyers gets loss when the futures price less then (F); if
The Futures price goes to E2 then the buyer the loss of (FL).
PAY-OFF FOR A SELLER OF FUTURES
93
P
PROFIT
E
E
LOSS
L
Figure 3.3
F = FUTURES PRICE
E1, E2 = SATTLEMENT PRICE
CASE 1:- The seller sold the future contract at (F); if the future goes to
E1 Then the seller gets the profit of (FP).
CASE 2:- The seller gets loss when the future price goes greater than
(F);
If the future price goes to E2 then the seller get the loss of
(FL).
MARGINS
93
Margins are the deposits which reduce counter party risk, arise in a
futures contract. These margins are collect in order to eliminate the
counter party risk. There are three types of margins:
Initial Margins:Whenever a future contract is signed, both buyer and seller are
required to post initial margins. Both buyers and seller are required to
make security deposits that are intended to guarantee that they will
infect be able to fulfill their obligation. These deposits are initial
margins and they are often referred as purchase price of futures
contract.
Mark to market margins:The process of adjusting the equity in an investors account in order to
reflect the change in the settlement price of futures contract is known
as MTM margin.
Maintenance margin:The investor must keep the futures account equity equal to or grater
than certain percentage of the amount deposited as initial margin. If
the equity goes less than that percentage of initial margin, then the
investor receives a call for an additional deposit of cash known as
maintenance margin to bring the equity up to the initial margin.
ROLE OF MARGINS
The role of margins in the futures contract is explained in the
following example: Siva Rama Krishna sold an ONGC July futures
contract to Nagesh at Rs.600; the following table shows the effect of
margins on the Contract. The contract size of ONGC is 1800. The
initial margin amount is say Rs. 30,000 the maintenance margin is 65%
of initial margin.
PRICING FUTURES
93
Pricing of futures contract is very simple. Using the cost-of-carry

logic, we calculate the fair value of a future contract. Every time the
observed price deviates from the fair value, arbitragers would enter
into trades to captures the arbitrage profit. This in turn would push the
futures price back to its fair value. The cost of carry model used for
pricing futures is given below.
F = SerT
Where:
F
Futures price
Spot Price of the Underlying
Cost of financing (using continuously
compounded
Interest rate)
T
Time till expiration in years

2.71828
(OR)
F = S (1+r- q) t
Where:
F
Futures price
Spot price of the underlying
Cost of financing (or) interest Rate
Expected dividend yield
Holding Period
FUTURES TERMINOLOGY
Spot price:
93
The price at which an asset trades in the spot market.

Futures Price:
The price at which the futures contract trades in the futures market.
Contract cycle:
The period over which a contract trades. The index futures contracts
on the NSE have one-month 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 January and a February
expiration contract ceases trading on the last Thursday of February.
On the Friday following the last Thursday, a new contract having a
three-month expiry is introduced for trading.
Expiry date:
It is the date specified in the futures contract. This is the last day on
which the contract will be traded, at the end of which it will cease to
exist.
Contract size:
The amount of asset that has to be delivered under one contract. For
instance, the contract size on NSEs futures markets is 200 Nifties.
Basis:
In the context of financial futures, basis can be defined as the futures
price minus the spot price. These will be a different basis for each
delivery month for each contract. In a normal market, basis will be
positive. This reflects that futures prices normally exceed spot prices.
Cost of carry:
The relationship between futures prices and spot prices can be
summarized in terms of what is known as the cost of carry. This
93
measures the storage cost plus the interest that is paid to finance the
asset less the income earned on the asset.
Initial margin:
The amount that must be deposited in the margin account at the time a
futures contract is first entered into is known as initial margin.
Marking-to-market:
In the futures market, at the end of each trading day, the margin
account is adjusted to reflect the investors gain or loss depending upon
the futures closing price. This is called marking-to-market.
Maintenance margin:
This is some what 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.
93
INTRODUCTION TO OPTIONS
In this section, we look at the next derivative product to be traded
on the NSE, namely options. Options are fundamentally different from
forward and futures contracts. An option gives the holder of the option
93
the right to do something. The holder does not have to exercise this
right. In contrast, in a forward or futures contract, the two parties have
committed themselves to doing something. Whereas it costs nothing
(except margin requirement) to enter into a futures contracts, the
purchase of an option requires as up-front payment.
DEFINITION
Options are of two types- calls and puts. Calls give the buyer the
right but not the obligation to buy a given quantity of the underlying
asset, at a given price on or before a given future date. Puts give the
buyers the right, but not the obligation to sell a given quantity of the
underlying asset at a given price on or before a given date.
HISTORY OF OPTIONS
Although options have existed for a long time, they wee traded
OTC, without much knowledge of valuation. The first trading in
options began in Europe and the US as early as the seventeenth
century. It was only in the early 1900s that a group of firms set up
what was known as the put and call Brokers and Dealers Association
with the aim of providing a mechanism for bringing buyers and sellers
together. If someone wanted to buy an option, he or she would contact
one of the member firms. The firms would then attempt to find a seller
or writer of the option either from its own clients of those of other
member firms. If no seller could be found, the firm would undertake
to write the option itself in return for a price.
This market however suffered form two deficiencies. First, there
was no secondary market and second, there was no mechanism to
guarantee that the writer of the option would honor the contract. In
1973, Black, Merton and scholes invented the famed Black-Scholes
93
formula. In April 1973, CBOE was set up specifically for the purpose
of trading options. The market for option developed so rapidly that by
early 80s, the number of shares underlying the option contract sold
each day exceeded the daily volume of shares traded on the NYSE.
Since then, there has been no looking back.
Option made their first major mark in financial history during the
tulip-bulb mania in seventeenth-century Holland. It was one of the
most spectacular get rich quick binges in history. The first tulip was
brought Into Holland by a botany professor from Vienna. Over a
decade, the tulip became the most popular and expensive item in Dutch
gardens. The more popular they became, the more Tulip bulb prices
began rising. That was when options came into the picture. They were
initially used for hedging. By purchasing a call option on tulip bulbs, a
dealer who was committed to a sales contract could be assured of
obtaining a fixed number of bulbs for a set price. Similarly, tulip-bulb
growers could assure themselves of selling their bulbs at a set price by
purchasing put options.
Later, however, options were increasingly
used by speculators who found that call options were an effective

vehicle for obtaining maximum possible gains on investment. As long
as tulip prices continued to skyrocket, a call buyer would realize
returns far in excess of those that could be obtained by purchasing tulip
bulbs themselves. The writers of the put options also prospered as bulb
prices spiraled since writers were able to keep the premiums and the
options were never exercised. The tulip-bulb market collapsed in 1636
and a lot of speculators lost huge sums of money. Hardest hit were put
writers who were unable to meet their commitments to purchase Tulip
bulbs.
93
PROPERTIES OF OPTION
Options have several unique properties that set them apart from
other securities. The following are the properties of option:
Limited Loss
High leverages potential
Limited Life
PARTIES IN AN OPTION CONTRACT
There are two participants in Option Contract.
Buyer/Holder/Owner of an Option:
The Buyer of an Option is the one who by paying the option premium
buys the right but not the obligation to exercise his option on the
seller/writer.
Seller/writer of an Option:
The writer of a call/put option is the one who receives the option
premium and is thereby obliged to sell/buy the asset if the buyer
exercises on him.
TYPES OF OPTIONS
The Options are classified into various types on the basis of various
variables. The following are the various types of options.
1. On the basis of the underlying asset:
On the basis of the underlying asset the option are divided in to two
types:
93
Index options:
These options have the index as the underlying. Some options are
European while others are American. Like index futures contracts,
index options contracts are also cash settled.
Stock options:
Stock Options are options on individual stocks. Options currently
trade on over 500 stocks in the United States. A contract gives the
holder the right to buy or sell shares at the specified price.
2. On the basis of the market movements :
On the basis of the market movements the option are divided into two
types. They are:
Call Option:
A call Option gives the holder the right but not the obligation to buy an
asset by a certain date for a certain price. It is brought by an investor
when he seems that the stock price moves upwards.
Put Option:
A put option gives the holder the right but not the obligation to sell an
asset by a certain date for a certain price. It is bought by an investor
when he seems that the stock price moves downwards.
3. On the basis of exercise of option:

On the basis of the exercise of the Option, the options are classified
into two Categories.
American Option:
93
American options are options that can be exercised at any time up to

the expiration date. Most exchange traded options are American.
European Option:
European options are options that can be exercised only on the
expiration date itself. European options are easier to analyze than
American options, and properties of an American option are frequently
deduced from those of its European counterpart.
PAY-OFF PROFILE FOR BUYER OF A CALL OPTION

The Pay-off of a buyer options depends on a spot price of an
underlying asset. The following graph shows the pay-off of buyers of
a call option.
93
PROFIT
ITM
S
E
ATM
OTM
LOSS
Figure 3.4
S=
Strike price
ITM = In the
Money
Sp = premium/loss
E1 =
Spot price 1
ATM = At the Money

OTM = Out of the
Money
E2 = Spot price 2
SR = Profit at spot price E1
CASE 1: (Spot Price > Strike price)
As the Spot price (E1) of the underlying asset is more than strike price
(S).
The buyer gets profit of (SR), if price increases more than E 1 then
profit also increase more than (SR)
CASE 2: (Spot Price < Strike Price)
As a spot price (E2) of the underlying asset is less than strike price (S)
The buyer gets loss of (SP); if price goes down less than E 2 then also
his loss is limited to his premium (SP)
PAY-OFF PROFILE FOR SELLER OF A CALL OPTION
The pay-off of seller of the call option depends on the spot price of the
underlying asset. The following graph shows the pay-off of seller of a
call option:
93
PROFIT
P
ITM
ATM
E
S
OTM
R
LOSS
Figure 3.5
S = Strike price
SP = Premium / profit
E1 = Spot Price 1
E2 = Spot Price 2
SR = loss at spot price E2
ITM = In the Money

ATM = At The money
OTM = Out of the Money
CASE 1: (Spot price < Strike price)

As the spot price (E1) of the underlying is less than strike price (S). The
seller gets the profit of (SP), if the price decreases less than E 1 then
also profit of the seller does not exceed (SP).
CASE 2: (Spot price > Strike price)
As the spot price (E2) of the underlying asset is more than strike price
(S) the Seller gets loss of (SR), if price goes more than E 2 then the loss
of the seller also increase more than (SR).
PAY-OFF PROFILE FOR BUYER OF A PUT OPTION
The Pay-off of the buyer of the option depends on the spot price of the
underlying asset. The following graph shows the pay-off of the buyer
of a call option.
93
PROFIT
ITM
S
E
ATM
OTM
LOSS
Figure 3.6
S = Strike price
ITM = In the Money
SP = Premium / loss
ATM = At the Money
E1 = Spot price 1
OTM = Out of the Money
E2 = Spot price 2
SR = Profit at spot price E1
As the spot price (E1) of the underlying asset is less than strike price
(S). The buyer gets the profit (SR), if price decreases less than E 1 then
profit also increases more than (SR).
(S),
The buyer gets loss of (SP), if price goes more than E 2 than the loss of
the buyer is limited to his premium (SP).
PAY-OFF PROFILE FOR SELLER OF A PUT OPTION
The pay-off of a seller of the option depends on the spot price of the
underlying asset. The following graph shows the pay-off of seller of a
put option.
93
PROFIT
P
ITM
ATM
OTM
R
LOSS
Figure 3.7
S = Strike price
SP = Premium/profit
E1 = Spot price 1
ITM = In the Money

ATM = At the Money
OTM = Out of the
Money
E2 = Spot price 2
SR = Loss at spot price E1
As the spot price (E1) of the underlying asset is less than strike price
(S), the seller gets the loss of (SR), if price decreases less than E 1 than
the loss also increases more than (SR).
(S), the seller gets profit of (SP), of price goes more than E 2 than the
profit of seller is limited to his premium (SP).
FACTORS AFFECTING THE PRICE OF AN OPTION
The following are the various factors that affect the price of an option
they are:
Stock Price:
93
The pay-off from a call option is an amount by which the stock price
exceeds the strike price. Call options therefore become more valuable
as the stock price increases and vice versa. The pay-off from a put
option is the amount; by which the strike price exceeds the stock price.
Put options therefore become more valuable as the stock price
increases and vice versa.
Strike price:
In case of a call, as a strike price increases, the stock price has to make
a larger upward move for the option to go in-the money. Therefore,
for a call, as the strike price increases option becomes less valuable
and as strike price decreases, option become more valuable.
Time to expiration:
Both put and call American options become more valuable as a time to
expiration increases.
Volatility:
The volatility of a stock price is measured of uncertain about future
stock price movements. As volatility increases, the chance that the
stock will do very well or very poor increases. The value of both calls
and puts therefore increases as volatility increase.
Risk- free interest rate:
The put option prices decline as the risk-free rate increases where as
the price of call always increases as the risk-free interest rate increases.
Dividends:Dividends have the effect of reducing the stock price on the
X- dividend rate. This has a negative effect on the value of call options
and a positive effect on the value of put options.
PRICING OPTIONS
93
An option buyer has the right but not the obligation to exercise on
the seller. The worst that can happen to a buyer is the loss of the
premium paid by him. His downside is limited to this premium, but
his upside is potentially unlimited. This optionality is precious and has
a value, which is expressed in terms of the option price. Just like in
other free markets, it is the supply and demand in the secondary market
that drives the price of an option.
There are various models which help us get close to the true price of
an option. Most of these are variants of the celebrated Black- Scholes
model for pricing European options.
Today most calculators and
spread-sheets come with a built-in Black- Scholes options pricing

formula so to price options we dont really need to memorize the
formula. All we need to know is the variables that go into the model.
The Black-Scholes formulas for the price of European calls and puts
on a non-dividend paying stock are:
93
Call option
CA = SN (d1) Xe- rT N (d2)
Put Option
PA = Xe- rT N (- d2) SN (- d1)
Where d1 = ln (S/X) + (r + v2/2) T
vT
And d2 = d1 - vT
Where
CA = VALUE OF CALL OPTION
PA = VALUE OF PUT OPTION
S = SPOT PRICE OF STOCK
N = NORMAL DISTRIBUTION
VARIANCE (V) = VOLATILITY
X = STRIKE PRICE
r = ANNUAL RISK FREE RETURN
T = CONTRACT CYCLE
e = 2.71828
r = ln (1 + r)
Table 3.8
93
OPTIONS TERMINOLOGY
Option price/premium:
Option price is the price which the option buyer pays to the option
seller. It is also referred to as the option premium.
Expiration date:
The date specified in the options contract is known as the expiration
date, the exercise date, the strike date or the maturity.
Strike price:
The price specified in the option contract is known as the strike price
or the exercise price.
DISTINCTION BETWEEN FUTURES AND OPTIONS
1.
2.
3.
4.
5.
6.
FUTURES
Exchange traded, with
Novation
Exchange defines the
product
Price is zero, strike
price moves
Price is Zero
Linear payoff
Both long and short
at risk
OPTIONS
1. Same as futures
2. Same as futures
3. Strike price is fixed,
price moves
4. Price is always positive
5. Nonlinear payoff
6. Only short at risk
Table 3.9
CALL OPTION
PREMIUM
93

INTRINSIC
VALUE
TIME
VALUE
TOTAL
VALUE
CONTRACT
STRIKE PRICE
560
540
520
0
0
0
2
5
10
2
5
10
OUT OF
THE
MONEY
500
15
15
AT THE
MONEY
480
460
440
20
40
60
10
5
2
30
45
62
IN THE
MONEY
Table 3.10
PUT OPTION
PREMIUM
CONTRACT
STRIKE PRICE
INTRINSIC
VALUE
TIME
VALUE
TOTAL
VALUE
560
540
520
60
40
20
2
5
10
62
45
30
IN THE
MONEY
500
15
15
AT THE
MONEY
480
460
440
0
0
0
10
5
2
10
5
2
OUT OF
THE
MONEY
Table 3.11
PREMIUM = INTRINSIC VALUE + TIME VALUE
The difference between strike values is called interval
93
TRADING INTRODUCTION
93
The futures & Options trading system of NSE, called NEAT-F&O

trading system, provides a fully automated screen-based trading for
Nifty futures & options and stock futures & Options on a nationwide
basis as well as an online monitoring and surveillance mechanism. It
supports an order driven market and provides complete transparency of
trading operations. It is similar to that of trading of equities in the cash
market segment.
The software for the F&O market has been developed to facilitate
efficient and transparent trading in futures and options instruments.
Keeping in view the familiarity of trading members with the current
capital market trading system, modifications have been performed in
the existing capital market trading system so as to make it suitable for
trading futures and options.
On starting NEAT (National Exchange for Automatic Trading)
Application, the log on (Pass Word) Screen Appears with the
Following Details.
1) User ID
2) Trading Member ID
3) Password NEAT CM (default Pass word)
4) New Pass Word
Note: - 1) User ID is a Unique
2) Trading Member ID is Unique & Function; it is Common
for all user of the Trading Member
3) New password Minimum 6 Characteristic, Maximum 8
characteristics only 3 attempts are accepted by the user to
enter the password to open the Screen
93
4) If password is forgotten the User required to inform the

Exchange in writing to reset the Password.
BASKET TRADING SYSTEM
1) Taking advantage for easy arbitration between future market and &
cash market difference, NSE introduce basket trading system by off
setting positions through off line-order-entry facility.
2) Orders are created for a selected portfolio to the ratio of their market
Capitalization from 1 lake to 30 crores.
1) Offline-order-entry facility: - generate order file in as specified
format out side the system & up load the order file in to the system by
invoking this facility in Basket trading system.
TRADING NETWORK
93
HUB ANTENNA
SATELLITE
NSE MAIN FRAME

BROKERS PREMISES
Figure 3.12
Participants in Security Market
1) Stock Exchange (registered in SEBI)-23 Stock Exchanges
93
2)
3)
4)
5)
Depositaries (NSDL,CDSL)-2 Depositaries

Listed Securities-9,413
Registered Brokers-9,519
FIIs-502
Highest Investor Population

State
Total No. Investors
% of Investors in India
Maharastra
9.11 Lakhs
28.50
Gujarat
5.36 Lakhs
16.75
Delhi
3.25 Lakhs
10.10%
Tamilnadu
2.30 Lakhs
7.205
West Bangal
2.14 Lakhs
6.75%
Andhra Pradesh
1.94 Lakhs
6.05%
Table 3.13
93
93
LOT SIZES OF SELECTED COMPANIES FOR ANALYSIS

CODE
LOT SIZE
COMPANY NAME
ACC
750
Associates Cement
Companies Ltd.
ARVIND MILLS
2150
Ar vind Mills Ltd.
BHEL
300
Bharat Heavy Electrical

Ltd.
The following tables explain about the table that took place
in futures and options between 25/02/08 to 29/02/08. The table
has various columns, which explains various factors involved in
derivative trading.
Date the day on which the trading took place.

Closing premium Premium for that day.
Open interest- No. of options that did not get exercised.
Traded Quantity No. of futures and options traded on that
day.
N.O.C No. of contracts traded on that day.
Closing PriceThe price of the futures at the end of the
trading day.
Spot parities relation to dividends.
93
Calculation of rate of return.
ANLYSIS AND INTERPRETATION:

FUTURES:
Futures are legally binding agreement to buy or sell an asset
at a cer tain time in the future at a cer tain price.
FORMULA:
Fo = So (1+r-d)
So = closing price of a market on that day.

r = Rate of return
d = Dividend
93
T = Time period
FUTURES OF ACC CEMENTS

Table: 1
Date
dd/mm/yy
High
Rs
Low
Rs
Close
Rs
Open
Int
('000)
Trd
Qty
N.O.C.
('000)
FO
25 /02/08
818.34 768.00 810.65
7146
986
2781
88582.23
26 /02/08
27 /02/08
28 /02/08
812.45 712.60 755.95

698.30 589.80 591.40
691.00 598.50 616.85
7322
1800
8168
1012
1943
891
3482
2591
2270
89881.33
89858.54
90154.83
29 /02/08
827.00 790.50 806.20
1785
1465
1953
90132.04
The above table has been given in the following graph.

Picture 1
93
FUTURES PRICE OF ACC

90500
90000
89500
89000
88500
88000
87500
25 /02/08
26 /02/08
27 /02/08
28 /02/08
29 /02/08
1
FO
Source:
The
data
has
been
collected
BUSINESS
STANDARED(paper) and Online Trading of KOTAK SECURITIES.

INTERPRETATION:
It is obser ved from the above mentioned table that the future
price (Fo) has increased tremendously due to increase in closing
price, decrease in open interest and reduction in value and volume
of futures.
FUTURES OF ARVIND MILLS
Table 2
Date
dd/mm/yy
High
Rs
Low
Rs
Close
Rs
93
Open Int
('000)
Trd Qty
('000)
N.O.C.
FO
25
26
27
28
29
/02/08
/02/08
/02/08
/02/08
/02/08
100.40
95.10
96.65
96.70
96.70
97.40
92.25
94.85
95.10
94.50
98.00
94.90
96.25
95.95
95.45
13360
10636
9129
5609
3038
5334
3053
4444
3990
5771
2481
1420
2067
1856
2684

Picture 2
FUTURES PRICE OF ARVIND MILLS
1520
25 /02/08
26 /02/08
27 /02/08
28 /02/08
29 /02/08
1500
1480
1460
1440
Fo
Source:
The data has been collected BUSINESS

(paper) and Online Trading of KOTAK SECURITIES.
STANDARDS
INTERPRETATION:
The above graph shows that the future price (Fo) has been
decrease due to decrease in closing price and decrease in open
interest and it is obser ved that increase in volume and value.
93
1515.3
1467.4
1488.3
1483.6
1475.9
FUTURES OF BHEL
Table 3
Date
dd/mm/yy
High Rs
Low Rs
Close
Rs
25
26
27
28
29
2010.00
2057.00
2260.00
2335.00
2405.10
1978.00
1995.00
2038.00
2210.00
2300.00
2006.40
2024.75
2221.60
2223.10
2350.00
/02/08
/02/08
/02/08
/02/08
/02/08
Open Int
('000)
2192
1586
1257
871
462
Trd
Qty
N.O.C.
('000)
988
3293
1405
4682
1508
5025
934
6147
1400
4667

Picture 3
FUTURE PRICE OF BHEL

225000
25 /02/08
220000
26 /02/08
215000
27 /02/08
210000
28 /02/08
205000
Fo
29 /02/08
Source:
The data has been collected BUSINESS STANDARDS (paper) and
Online Trading of KOTAK SECURITIES.
93
FO
218768
212665
218096
222906
219881
INTERPRETATION:
From the above mentioned table it is obser ved that the
future price (Fo) has shown fl uctuation due to fl uctuation in
closing price and volume, value is increase and it is obser ved that
open interest is decrease.
OPTIONS: Options are two types. They are CALL OPTION and
PUT OPTION
CALL OPTION : A Call option is bought by an investor when he
seems that the stock price moves upwards. A call option gives the
holder of the option the right but not the obligation to buy an asset
by an cer tain date for a cer tain price.
PUT OPTION :
A Put option is bought by an investor when he seems that the
stock price moves downwards. A put option gives the holder of the
option the right but not the obligation to sell asset by an cer tain
date for a cer tain price.
Formula:
Profi t of the holder
Premium*
(Spot
Price
Strike
Price)
(Lot Size) in case of call option.
93
Profi t of the holder
Premium* (Lost Size) in case of Put

Option.
Source:
The
data
has
been
collected
through
BUSINESS
STANDARDS (Paper) and Online Trading of KOTAK SECURITIES.
The following table of N et pay-off explain the profi t/loss of

option
holder/writer
of
ACC
for
the
week
25/02/2008
to
29/02/2008.
PROFIT/LOSS POSITION OF CALL OPTION BUYER OF ACC
Table 1
S POT
P RI CE
STRI KE
P RI CE
P RE MI UM
WHE THE R
EX E RCI S E D
BUYE RS
GAI N/ LO SS
WE I TE R
GAI N/ LO SS
818.34
818.34
818.34
818.34
800
820
840
860
27.00
10.45
5.30
1.90
YES
YES
NO
NO
150.00
2737.50
-3975.00
-1425.00
-150.00
-2737.50
13875.00
26325.00
93
93
PROFIT/LOSS POSITION OF PUT OPTION BUYER/WRITER OF

ACC
Table 2
93
SPOT
PRICE
818.34
818.34
818.34
818.34
STRIKE PREMIUM WHETHER

PRICE
EXERCISED
800
0.20
NO
820
2.40
NO
840
8.90
NO
860
12.00
YES
93
BUYERS
WEITER
GAIN/LOSS GAIN/LOSS
-150
150
-1800
1800
-6675
6675
900
-900
INTERPERATATION:
From the above graph it obser ved that the buyer get Profi t
when the Strike Price is less than the spot price and it is also
obser ved that the writer get loss when the strike price is more
than the spot price.
The following table of Net pay-off explains the profi t/loss of option
holder/writer of ARAVIND MILL
PROFIT/LOSS POSITION OF CALL OPTION BUYER/WRITER OF

ARAVINDMILL
Table 3
93
SPOT
PRICE
STRIKE
WHETHER
PRICE
PREMIUM EXERCISED
85
12.50
YES
90
8.30
YES
95
4.30
YES
100
2.00
NO
100.40
100.40
100.40
100.40
BUYERS
WRITERS
GAIN/LOSS GAIN/LOSS
537.5
-537.5
1182.5
-1182.5
3332.5
-3332.5
-4300
9137.5
Profit/Loss Graph of the Writer with Strike Price of

Call Option
6000
4000
2000
STRIKE PRICE
WRITERS GAIN/LOSS
0
1
-2000
-4000
Profit and Loss Graph of the Buyer with Strike Price of

Call Option
4000
2000
0
-2000
STRIKE PRICE
BUYERS GAIN/LOSS
-4000
-6000

ARVIND MILL
Table 4
93
SPOT
PRICE
100.40
100.40
100.40
100.40
100.40
STRIKE
PRICE
80
85
90
95
100
PREMIUM
WHETHER
EXERCISED
NO
NO
NO
NO
YES
0.25
0.05
0.45
1.300
4.900
BUYERS
GAIN/LOSS
-537.5
-967.5
-2795
-10535
5697.5
WRITERS
GAIN/LOSS
537.5
967.5
2795
10535
-5697.5
Profit/Loss graph of the Buyer with Strike Price

Of Put Option
10000
5000
0
1
-5000
STRIKE PRICE
BUYERS GAIN/LOSS
-10000
-15000
Profit/Loss Graph of the Writer with Strike

Price of Put Option
15000
10000
STRIKE PRICE
5000
0
-5000
-10000
93
WRITER'S
GAIN/LOSS
INTERPRETATION:
It is obser ved from the above mentioned tables that the
strike price is less than the spot price the buyer will get profi t and
strike price is more than the spot price the buyer will get loss then
obviously in case of writer it is vice-versa.
The following table of N et pay-off explains the profi t/loss of

holder/writer of BHEL
PROFIT/LOSS POSITION OF CALL OPTION BUYER/WRITER OF
BHEL
Table 5
SPOT
PRICE
2010.00
2010.00
2010.00
2010.00
2010.00

PRICE
EXERCISED
1830
25.00
YES
1860
40.00
YES
1890
19.00
NO
1920
10.00
NO
1980
20.00
NO
93
BUYERS
GAIN/LOSS
5700
7800
-5700
-3000
-6000
WRITER'S
GAIN/LOSS
-5700
-7800
5700
3000
6000
93

BHEL
Table 6
SPOT
BUYERS
WRITER'S
PRICE
PRICE
EXERCISED GAIN/LOSS GAIN/LOSS
1874.00
1800
20.00
NO
-6000
6000
1874.00
1830
28.55
NO
-8565
8565
1874.00
1860
31.00
NO
-9300
9300
93
INTERPRETATION:
From the above call option and put option tables it is
obser ved that the writer get profi t when the strike price is more
than the spot price and the writer get loss when the strike price is
less than the spot price and it is obser ved that the buyer it is viceversa.
93
CALCULATION OF FUTURE PRICE

On Feb 25 t h :
If an investor holds the following contract of the Acc
Future closing price=R.s.818.34
Equity share capital=R.s.179.58
N et profi t=4446.20
Preference dividend=0
Dividends=0.07
r = N et profi t-preference dividend
Equity share capital
*100
93
r = 4446.20-0/179.58.00*100=2475.88
=818.34(1+2475.88-0.07)
= 818.34(15194.208)
=288582.23
On Feb 25 t h :
If an investor holds the following contract of the Arvind mills
Future closing price=R.s100.40
N et profi t=484.81
Dividends=0.01
r = N et profi t-preference dividend
*100
R = 484.18-0/195.38*100=248.14
= 100.40 (1+248.14-0.01) 3
=100.40 (1+248.13) 3
=11515.31
On Feb 25 t h :
If an investor holds the following contract of the BHEL
Future closing price=R.s.2010.40
93

N et profi t=158163.56
Dividends=0.08
r = N et profi t preference dividend
r = 158163.56-0/195.38*100=486.66
= 2010.40 (1+486.66-0.08) 3
= 2010.40487.58) 3
= 518768.
93
*100
FINDINGS
The
above
analysis
of
futures
and
options
of
ACC,
ARVINDMILLS and BHELhad shown a positive market in the

week.
The major factors that infl uence the futures and options
market are the cash market, foreign institutional investor
involvement, News related to the underlying asset, national
and international markets, Researchers view etc.
In cash market the profi t/loss is limited but where in future
and option an investor can enjoy unlimited profi t/loss.
It
is
recommended
that
SEBI
should
take
measures
in
improving awareness about the future and option market as it

is launched very recently.
At present scenario the derivatives market is increased to a
great position. Its daily turnover reaches to the equal stage of
cash market. The average daily turnover of the NSE in
derivative is four lacks volume.
The derivatives are mainly used for hedging purpose.
In cash market the investor has to pay the total money, but in
derivatives has to pay the premiums or margins, which are
some percentage of the total money.
93
Determination of the future price is mayoral based on the

number of contracts of the scrip. Hence value, volume, open
interest, closing price of that scrip is infl uenced by the
number of contracts.
SUGGESTIONS
o In a bearish market it is suggested to an investor to opt for
put option in order to minimize Profi ts.
o In a bullish market it is suggested to an investor to apt for
call option in order to maximize Profi ts.
o It is suggested to an investor to keep in mind the time or
expiry
duration
of
futures
and
options
contract
before
trading. The lengthy time, the risk is low and profi t making.
The fewer time may be high risk and chances of loss
making.
o At present futures and options are traded on NSE. It is
recommended to SEBI to take actions in trading of futures
and options in other regional exchanges.
o SEBI has to take fur ther steps in the risk management
mechanism.
93
o Contract size should be minimized because small investors

can not aff ord this much of huge premiums.
BIBLIOGRAPHY
WEBSITES
WWW.derivativesindia.com
www.kotaksecurities.com
www.nseindia.com
93
www.bseindia.com
BOOKS:
FINANCIAL MANAGEMENT
PRASANNA CHANDRA
DERIVATIVES CORE MODULE
NCFM MATERIAL
SAPM
PRASANNA CHANDRA
JOURNALS :
FINANCIAL EXPRESS
BUSINESS STANDARDS
93
MARKET WATCH WINDOWS

BLUE COLOUR INDICATE SHARE VALUE INCREASE
RED COLOUR INDICATE SHARE VALUE DECREASE
NSE SCRIPS
93
Figure 5.1
NSE & BSE SCRIPS
93
Figure 5.2
BUY ORDER FORM
93
Figure 5.3
SELL ORDER FORM
93
Figure 5.4
TRADE BOOK
93
Figure 5.5
93

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Derivatives (Futures & Options)

Derivatives (Futures & Options)

Submitted in partial fulfillment for the requirement of summer

Derivatives (Futures & Options)

Derivatives (Futures & Options)

was carried out byM.INDRA SHEKHAR under my

Name and address of the Guide

Signature of the Guide

Derivatives (Futures & Options)

Derivatives (Futures & Options)

Derivatives (Futures & Options)

The Kotak Mahindra Group

Executive Vice Chairman & Managing Director

The Kotak Mahindra Group was born in 1985 as Kotak Capital

Kotak Mahindra Finance Limited starts the activity of Bill Discounting

Derivatives (Futures & Options)

Enters the Funds Syndication sector

Derivatives (Futures & Options)

Derivatives (Futures & Options)

Prime Ranking Award (2003-04) - Largest Distributor of IPO's

Finance Asia Award (2004) - India's best Equity House

Finance Asia Award (2005)-Best Broker in India

Euro money Award (2005)-Best Equities House in India

Finance Asia Award (2006) - Best Broker in India

Euro money Award (2006) - Best Provider of Portfolio

Kotak Securities Ltd - Institutional Equities

Derivatives (Futures & Options)

Kotak has wholly-owned subsidiaries with offices in Mauritius,

Derivatives (Futures & Options)

Derivatives (Futures & Options)

other Tier III cities, examples of which are Nagpur, Coimbotore,

Derivatives (Futures & Options)

We are sponsored by Kotak Mahindra Bank Limited, one of

Derivatives (Futures & Options)

Scope of the Study

Derivatives (Futures & Options)

Derivatives (Futures & Options)

Derivatives (Futures & Options)

Mercantile Exchange. During the Mid eighties, financial futures

Derivatives (Futures & Options)

DERIVATIVE PRODUCTS (TYPES)

Derivatives (Futures & Options)

The acronym LEAPS means Long-Term Equity Anticipation

Derivatives (Futures & Options)

PARTICIPANTS IN THE DERRIVATIVES MARKETS

Derivatives (Futures & Options)

FUNCTIONS OF THE DERIVATIVES MARKET

discovery of future as well as current prices.

The derivative markets helps to transfer risks from those

With the introduction of

derivatives, the underlying market witness higher trading

In the absence of an organized

derivatives market, speculators trade in the underlying cash

Derivatives (Futures & Options)

markets. Margining, monitoring and surveillance of the

They often energize others to

create new businesses, new products and new employment

SCOPE OF THE STUDY