Executive Summary: Title of The Analysis

Analysis of Derivatives and Stock Broking at Apollo Sindhoori
Executive Summary
Title of the analysis
Analysis of Derivatives and Stock Broking at Apollo Sindhoori capital Investment ltd. The function of the financial market is to facilitate the transfer of funds from surplus sectors (lenders) to deficit sector (borrowers) Indian financial system consist of the money market and capital market. Depository is an organization where the securities of a shareholder are held in the electronic form at the request of the shareholder through a medium of a depository participant. To handle the securities in electronic form as per the Depository Act 1996, two Depositories are registered with SEBI. They are 1. National Securities Depository Ltd (NSDL) 2. Central Depository Services (India) ltd (CSDL) A derivative is a financial instrument that derives its value from an underlying asset. This underlying asset can be stocks, bonds currency, commodities, metals and even intangible. Like stock indices. There are different types of derivatives like Forwards, Futures, Options, and Swaps. A future is a contract to buy or sell an asset at a specified future date at a specified price. Options are deferred delivery contracts that give the buyers the right, but not the obligation, to buy or sell a specified underlying at a price on or before a specified date. ASCI computer share private Ltd. Is a joint venture between computer share Australia and ASCI consultants Ltd. India in the registry management services industry. Computer share Australia is the worlds largest and only global share registry providing financial market services and technology to the global securities industry. ASCI corporate and mutual fund share registry and investor services business, Indias No.1Registrar and transfer agent and rated as Indias most admired registrar for its over all excellence in volume management, quality process and technology driven services.
BABASAB PATIL PROJECT REPORT ON FINANCE
Computer share has over 6000 experienced professionals; computer share operates in five continents, providing services and solutions to listed companies, investors, employees, exchanges and other financial institutions while ASCI has handled over 675 issues as Registrar to Issues servicing over 16 million investors from multiple locations across India. ASCI Computer share is all geared up to establish a new paradigm in service delivery driven by benchmark operations management practices, the highest quality standards and state-of the-art technology to service its clients and the investor community at large. The rapid developments in the Indian securities. This report is delivered in to 2 parts; each part is prepared on the basis of the analysis carried on in the company, of the first part of the report makes us familiar of the company, its quality policy, quality objectives and its plans. The second part contains the analysis on derivatives, stock broking process and its service offered by ASCI to its clients. The objective of the analysis are to analysis of derivatives products, trading systems and process, clearing and settlement, to know the process of stock broking, the calculation of brokerage, how to get registered with ASCI in order to buy and sell the shares.
Objective of the analysis

Getting an in-depth knowledge of working of derivatives market with special reference to the stock exchanges. Understanding the role of stock broking in capital market and derivatives market. To know the overview of the market, to study about the settlement procedure in the stock exchange. To analysis about the intermediaries, their functioning and importance of their presence in the capital market and study about the action trading in the stock exchange
Need for the study

Financial Derivatives are quite new to the Indian Financial Market, but the derivatives market has shown an immense potential which is visible by the growth it has achieved in the recent past, In the present changing financial environment and an increased exposure towards financial risks, It is of immense importance to have a good working knowledge of Derivatives.
Methodology:Methodology explains the methods used in collecting project. I have collected the primary data from the internal guide and the clients who use visit and trade in the ASCI stock broking Ltd. The secondary data about the online trading is collected from the various websites. Websites Magazines News papers The data for the analysis has been collected from NSE websites. information to carry out the
Introduction to Organization:
ASCI, is a premier integrated financial services provider, and ranked among the top five in the country in all its business segments, services over 16 million individual investors in various capacities, and provides investor services to over 300 corporate, comprising the who is who of Corporate India. ASCI covers the entire spectrum of financial services such as Stock broking, Depository Participants, Distribution of financial products - mutual funds, bonds, fixed deposit, equities, Insurance Broking, Commodities Broking, Personal Finance Advisory Services, Merchant Banking & Corporate Finance, placement of equity, IPOs, among others. ASCI has a professional management team and ranks among the best in technology, operations and research of various industrial segments The birth of ASCI was on a modest scale in 1981. It began with the vision and enterprise of a small group of practicing Chartered Accountants who founded the flagship company ASCI Consultants Limited. It started with consulting and financial accounting automation, and carved inroads into the field of registry and share accounting by 1985. Since then, they have utilized their experience and superlative expertise to go from strength to strengthto better their services, to provide new ones, to innovate, diversify and in the process, evolved ASCI as one of Indias premier integrated financial service enterprise. Thus over the last 20 years ASCI has traveled the success route, towards building a reputation as an integrated financial services provider, offering a wide spectrum of services. And they have made this journey by taking the route of quality service, path breaking innovations in service, versatility in service and finallytotality in service. Our highly qualified manpower, cutting-edge technology, comprehensive infrastructure and total customer-focus has secured for us the position of an emerging financial services giant enjoying the confidence and support of an enviable clientele across diverse fields in the financial world.
Vision of ASCI: To be amongst most trusted power utility company of the country by providing environment friendly power on most cost effective basis, ensuring prosperity for its stakeholders and growth with human face. Mission of ASCI: To ensure most cost effective power for sustained growth of India. To provide clean and green power for secured future of countrymen. To retain leadership position of the organization in Hydro Power generation, while working with dedication and innovation in every project we undertake. To maintain continuous pursuit for cost effectiveness enhanced productivity for ensuring financial health of the organization, to take care of stakeholders aspirations continuously. To be a technology driven, transparent organization, ensuring dignity and respect for its team members. To inculcate value system all cross the organization for ensuring trustworthy relationship with its constituent associates & stakeholders. To continuously upgrade & update knowledge & skill set of its human resources. To be socially responsible through community development by leveraging resources and knowledge base. To achieve excellence in every activity we undertake.
Quality policy of ASCI: To achieve and retain leadership, ASCI shall aim for complete customer satisfaction, by combining its human and technological resources, to provide superior quality financial services. In the process, ASCI will strive to exceed Customer's expectations. Quality Objectives As per the Quality Policy, ASCI will:
Build in-house processes that will ensure transparent and harmonious relationships with its clients and investors to provide high quality of services.
Establish a partner relationship with its investor service agents and vendors that will help in keeping up its commitments to the customers. Provide high quality of work life for all its employees and equip them with adequate knowledge & skills so as to respond to customer's needs. Continue to uphold the values of honesty & integrity and strive to establish unparalleled standards in business ethics. Use state-of-the art information technology in developing new and innovative financial products and services to meet the changing needs of investors and clients.
Strive to be a reliable source of value-added financial products and services and constantly guide the individuals and institutions in making a judicious choice of same.
Strive to keep all stake-holders (shareholders, clients, investors, employees, suppliers and regulatory authorities) proud and satisfied
ACTIVITIES CARRIED OUT BY ASCI STOCK BROKING LIMITED 1. Share Broking. 2. Demat & Remat Services. 3. Mutual Funds. 4. Investments. 5. Personal Tax planning. 6. Insurance Advisory. The explanation for the above mentioned points are as follows:
Services and qualities of ASCI Ltd

Quality Objectives As per the Quality Policy, ASCI will:
Build in-house processes that will ensure transparent and harmonious relationships with its clients and investors to provide high quality of services.
Establish a partner relationship with its investor service agents and vendors that will help in keeping up its commitments to the customers. Provide high quality of work life for all its employees and equip them with adequate knowledge & skills so as to respond to customer's needs. Continue to uphold the values of honesty & integrity and strive to establish unparalleled standards in business ethics. Use state-of-the art information technology in developing new and innovative financial products and services to meet the changing needs of investors and clients.
Strive to be a reliable source of value-added financial products and services and constantly guide the individuals and institutions in making a judicious choice of same.
Strive to keep all stake-holders (shareholders, clients, investors, employees, suppliers and regulatory authorities) proud and satisfied.
The services provided by the ASCI: A). my portfolio Portfolio planner Risk quotient Equity portfolio My net worth
B). Planners Goal planner Retirement planner Yield calculator Risk hedger
C). Publications The Finapolis ASCI Bazaar Baatein.
DERIVATIVES Introduction:
BSE created history on June 9, 2000 by launching the first Exchange traded Index Derivative Contract i.e. futures on the capital market benchmark index - the BSE Sensex. The inauguration of trading was done by Prof. J.R. Varma, member of SEBI and chairman of the committee responsible for formulation of risk containment measures for the Derivatives market. The first historical trade of 5 contracts of June series was done on June 9, 2000 at 9:55:03 a.m. between M/s Kaji and Maulik Securities Pvt. Ltd. and M/s Emkay Share and Stock Brokers Ltd. at the rate of 4755. In the sequence of product innovation, the exchange commenced trading in Index Options on Sensex on June 1, 2001. Stock options were introduced on 31 stocks on July 9, 2001 and single stock futures were launched on November 9, 2002. September 13, 2004 marked another milestone in the history of Indian Capital Markets, the day on which the Bombay Stock Exchange launched Weekly Options, a unique product unparallel in derivatives markets, both domestic and international. BSE permitted trading in weekly contracts in options in the shares of four leading companies namely Reliance, Satyam, State Bank of India, and Tisco in addition to the flagship index-Sensex.
Indian derivatives markets 1. Rise of Derivatives

The global economic order that emerged after World War II was a system where many less developed countries administered prices and centrally allocated resources. Even the developed economies operated under the Bretton Woods system of fixed exchange rates. The system of fixed prices came under stress from the 1970s onwards. High inflation and unemployment rates made interest rates more volatile. The Bretton Woods system was dismantled in 1971, freeing exchange rates to fluctuate. Less developed countries like India began opening up their economies and allowing prices to vary with market conditions. Price fluctuations make it hard for businesses to estimate their future production costs and revenues. Derivative securities provide them a valuable set of tools for managing this risk.
2. Definition and Uses of Derivatives

A derivative security is a financial contract whose value is derived from the value of something else, such as a stock price, a commodity price, an exchange rate, an interest rate, or even an index of prices. Some simple types of derivatives: forwards, futures, options and swaps. Derivatives may be traded for a variety of reasons. A derivative enables a trader to hedge some preexisting risk by taking positions in derivatives markets that offset potential losses in the underlying or spot market. In India, most derivatives users describe themselves as hedgers and Indian laws generally require that derivatives be used for hedging purposes only. Another motive for derivatives trading is speculation (i.e. taking positions to profit from anticipated price movements). In practice, it may be difficult to distinguish whether a particular trade was for hedging or speculation, and active markets require the participation of both hedgers and speculators. A third type of trader, called arbitrageurs, profit from discrepancies in the relationship of spot and derivatives prices, and thereby help to keep markets efficient.
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Jogani and Fernandez (2003) describe Indias long history in arbitrage trading, with line operators and traders arbitraging prices between exchanges located in different cities, and between two exchanges in the same city. Their study of Indian equity derivatives markets in 2002 indicates that markets were inefficient at that time. They argue that lack of knowledge, market frictions and regulatory impediments have led to low levels of capital employed. Price volatility may reflect changes in the underlying demand and supply conditions and thereby provide useful information about the market. Thus, economists do not view volatility as necessarily harmful. Speculators face the risk of losing money from their derivatives trades, as they do with other securities. There have been some well-publicized cases of large losses from derivatives trading. In some instances, these losses stemmed from fraudulent behavior that went undetected partly because companies did not have adequate risk management systems in place. In other cases, users failed to understand why and how they were taking positions in the derivatives. Derivatives in arbitrage trading in India. However, more recent evidence suggests that the efficiency of Indian equity derivatives markets may have improved. 3. Exchange-Traded and Over-the-Counter Derivative Instruments OTC (over-the-counter) contracts, such as forwards and swaps, are bilaterally negotiated between two parties. The terms of an OTC contract are flexible, and are often customized to fit the specific requirements of the user. OTC contracts have substantial credit risk, which is the risk that the counterparty that owes money defaults on the payment. In India, OTC derivatives are generally prohibited with some exceptions: those that are specifically allowed by the Reserve Bank of India (RBI) or, in the case of commodities (which are regulated by the Forward Markets Commission), those that trade informally in havala or forwards markets. An exchange-traded contract, such as a futures contract, has a standardized format that specifies the underlying asset to be delivered, the size of the contract, and the logistics of delivery. They trade on organized exchanges with prices determined by the interaction of many buyers and sellers. In India, two exchanges offer derivatives trading: the Bombay Stock Exchange (BSE) and the National Stock
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Exchange (NSE). However, NSE now accounts for virtually all exchangetraded derivatives in India, accounting for more than 99% of volume in 2003-2004. Contract performance is guaranteed by a clearinghouse, which is a wholly owned subsidiary of the NSE. Margin requirements and daily marking-to-market of futures positions substantially reduce the credit risk of exchange traded contracts, relative to OTC contracts. 4. Development of Derivative Markets in India Derivatives markets have been in existence in India in some form or other for a long time. In the area of commodities, the Bombay Cotton Trade Association started futures trading in 1875 and, by the early 1900s India had one of the worlds largest futures industry. In 1952 the government banned cash settlement and options trading and derivatives trading shifted to informal forwards markets. In recent years, government policy has changed, allowing for an increased role for market-based pricing and less suspicion of derivatives trading. The ban on futures trading of many commodities was lifted starting in the early 2000s, and national electronic commodity exchanges were created. In the equity markets, a system of trading called badla involving some elements of forwards trading had been in existence for decades. However, the system led to a number of undesirable practices and it was prohibited off and on till the Securities and a clearinghouse guarantees performance of a contract by becoming buyer to every seller and seller to every buyer. Customers post margin (security) deposits with brokers to ensure that they can cover a specified loss on the position. A futures position is marked-to-market by realizing any trading losses in cash on the day they occur. Badla allowed investors to trade single stocks on margin and to carry forward positions to the next settlement cycle. Earlier, it was possible to carry forward a position indefinitely but later the maximum carry forward period was 90 days. Unlike a futures or options, however, in a badla trade there is no fixed expiration date, and contract terms and margin requirements are not standardized. Derivatives Exchange Board of India (SEBI) banned it for good in 2001. A series of reforms of the stock market between 1993 and 1996 paved the way for the development of exchange traded equity derivatives markets in India. In 1993, the BABASAB PATIL PROJECT REPORT ON FINANCE 12
government created the NSE in collaboration with state-owned financial institutions. NSE improved the efficiency and transparency of the stock markets by offering a fully automated screen-based trading system and real-time price dissemination. In 1995, a prohibition on trading options was lifted. In 1996, the NSE sent a proposal to SEBI for listing exchange-traded derivatives. The report of the L. C. Gupta Committee, set up by SEBI, recommended a phased introduction of derivative products, and bi-level regulation (i.e., selfregulation by exchanges with SEBI providing a supervisory and advisory role). Another report, by the J. R. Varma Committee in 1998, worked out various operational details such as the margining systems. In 1999, the Securities Contracts (Regulation) Act of 1956, or SC(R)A, was amended so that derivatives could be declared securities. This allowed the regulatory fMr.Xework for trading securities to be extended to derivatives. The Act considers derivatives to be legal and valid, but only if they are traded on exchanges. Finally, a 30-year ban on forward trading was also lifted in 1999. The economic liberalization of the early nineties facilitated the introduction of derivatives based on interest rates and foreign exchange. A system of market-determined exchange rates was adopted by India in March 1993. In August 1994, the rupee was made fully convertible on current account. These reforms allowed increased integration between domestic and international markets, and created a need to manage currency risk. 5. Derivatives Users in India The use of derivatives varies by type of institution. Financial institutions, such as banks, have assets and liabilities of different maturities and in different currencies, and are exposed to different risks of default from their borrowers. Thus, they are likely to use derivatives on interest rates and currencies, and derivatives to manage credit risk. Non-financial institutions are regulated differently from financial institutions, and this affects their incentives to use derivatives. Indian insurance regulators, for example, are yet to issue guidelines relating to the use of derivatives by insurance companies. In India, financial institutions have not been heavy users of exchange-traded derivatives so far, with their contribution to total value of NSE trades being less than BABASAB PATIL PROJECT REPORT ON FINANCE 13
8% in October 2005. However, market insiders feel that this may be changing, as indicated by the growing share of index derivatives (which are used more by institutions than by retail investors). In contrast to the exchange-traded markets, domestic financial institutions and mutual funds have shown great interest in OTC fixed income instruments. Transactions between banks dominate the market for interest rate derivatives, while state-owned banks remain a small presence. Corporations are active in the currency forwards and swaps markets, buying these instruments from banks.
Why do institutions not participate to a greater extent in derivatives markets?

Some institutions such as banks and mutual funds are only allowed to use derivatives to hedge their existing positions in the spot market, or to rebalance their existing portfolios. Since banks have little exposure to equity markets due to banking regulations, they have little incentive to trade equity derivatives. Foreign investors must register as foreign institutional investors (FII) to trade exchange-traded derivatives, and be subject to position limits as specified by SEBI. Alternatively, they can incorporate locally as under RBI directive, banks direct or indirect (through mutual funds) exposure to capital markets instruments is limited to 5% of total outstanding advances as of the previous year-end. Some banks may have further equity exposure on account of equities collaterals held against loans in default. FIIs have a small but increasing presence in the equity derivatives markets. They have no incentive to trade interest rate derivatives since they have little investments in the domestic bond markets. It is possible that unregistered foreign investors and hedge funds trade indirectly, using a local proprietary trader as a front. Retail investors (including small brokerages trading for themselves) are the major participants in equity derivatives, accounting for about 60% of turnover in October 2005, according to NSE. The success of single stock futures in India is unique, as this instrument has generally failed in most other countries. One reason for this success may be retail investors prior familiarity with badla trades which shared some features of derivatives trading. Another reason may be the small size of the futures contracts, compared to similar contracts in other countries. Retail investors also dominate the markets for commodity derivatives, due in part to their longstanding expertise in trading in the havala or forwards markets. BABASAB PATIL PROJECT REPORT ON FINANCE 14
Why have derivatives?

Derivatives have become very important in the field finance. They are very important financial instruments for risk management as they allow risks to be separated and traded. Derivatives are used to shift risk and act as a form of insurance. This shift of risk means that each party involved in the contract should be able to identify all the risks involved before the contract is agreed. It is also important to remember that derivatives are derived from an underlying asset. This means that risks in trading derivatives may change depending on what happens to the underlying asset. A derivative is a product whose value is derived from the value of an underlying asset, index or reference rate. The underlying asset can be equity, forex, commodity or any other asset. For example, if the settlement price of a derivative is based on the stock price of a stock for e.g. Infosys, which frequently changes on a daily basis, then the derivative risks are also changing on a daily basis. This means that derivative risks and positions must be monitored constantly. Why Derivatives are preferred? Retail investors will find the index derivatives useful due to the high correlation of the index with their portfolio/stock and low cost associated with using index futures for hedging. Looking Ahead Clearly, the nascent derivatives market is heading in the right direction. In terms of the number of contracts in single stock derivatives, it is probably the largest market globally. It is no longer a market that can be ignored by any serious participant. With institutional participation set to increase and a broader product rollout inevitable, the market can only widen and deepen further. How does F&O trading impact the market?
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The start of a new derivatives contract pushes up prices in the cash market as operators take fresh positions in the new month series in the first week of every new contract. This buying in the derivatives segment pushes up future prices. Higher future prices are seen as indicators of bullish prices in the days to come. Thus, higher prices due to new month buying in the derivatives market lead to buying in the physical market. This lifts prices in the cash market as well.
The huge surge in open positions has coincided with the market indexes reaching historic highs. This shows that the two segments are linked.
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FUTURES CONTRACT:
A futures contract is similar to a forward contract in terms of its working. The difference is that contracts are standardized and trading is centralized. Futures markets are highly liquid and there is no counterparty risk due to the presence of a clearinghouse, which becomes the counterparty to both sides of each transaction and guarantees the trade. What is an Index? To understand the use and functioning of the index derivatives markets, it is necessary to understand the underlying index. A stock index represents the change in value of a set of stocks, which constitute the index. A market index is very important for the market players as it acts as a barometer for market behavior and as an underlying in derivative instruments such as index futures. The Sensex and Nifty In India the most popular indices have been the BSE Sensex and S&P CNX Nifty. The BSE Sensex has 30 stocks comprising the index which are selected based on market capitalization, industry representation, trading frequency etc. It represents 30 large well-established and financially sound companies. The Sensex represents a broad spectrum of companies in a variety of industries. It represents 14 major industry groups. Then there is a BSE national index and BSE 200. However, trading in index futures has only commenced on the BSE Sensex. While the BSE Sensex was the first stock market index in the country, Nifty was launched by the National Stock Exchange in April 1996 taking the base of November 3, 1995. The Nifty index consists of shares of 50 companies with each having a market capitalization of more than Rs 500 crore. Futures and stock indices
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For understanding of stock index futures a thorough knowledge of the composition of indexes is essential. Choosing the right index is important in choosing the right contract for speculation or hedging. Since for speculation, the volatility of the index is important whereas for hedging the choice of index depends upon the relationship between the stocks being hedged and the characteristics of the index. Choosing and understanding the right index is important as the movement of stock index futures is quite similar to that of the underlying stock index. Volatility of the futures indexes is generally greater than spot stock indexes. Everytime an investor takes a long or short position on a stock, he also has an hidden exposure to the Nifty or Sensex. As most often stock values fall in tune with the entire market sentiment and rise when the market as a whole is rising. Retail investors will find the index derivatives useful due to the high correlation of the index with their portfolio/stock and low cost associated with using index futures for hedging 6.1 Understanding index futures A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Index futures are all futures contracts where the underlying is the stock index (Nifty or Sensex) and helps a trader to take a view on the market as a whole. Index futures permits speculation and if a trader anticipates a major rally in the market he can simply buy a futures contract and hope for a price rise on the futures contract when the rally occurs. In India we have index futures contracts based on S&P CNX Nifty and the BSE Sensex and near 3 months duration contracts are available at all times. Each contract expires on the last Thursday of the expiry month and simultaneously a new contract is introduced for trading after expiry of a contract.
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Example: Futures contracts in Nifty in July 2001

Contract month July 2001 August 2001 September 2001 Expiry/settlement July 26 August 30 September 27
On July 27
Contract month August 2001 September 2001 October 2001 Expiry/settlement August 30 September 27 October 25
The permitted lot size is 200 or multiples thereof for the Nifty. That is you buy one Nifty contract the total deal value will be 200*1100 (Nifty value)= Rs 2,20,000. In the case of BSE Sensex the market lot is 50. That is you buy one Sensex futures the total value will be 50*4000 (Sensex value)= Rs 2,00,000. Hedging The other benefit of trading in index futures is to hedge your portfolio against the risk of trading. In order to understand how one can protect his portfolio from value erosion let us take an example. Illustration: Mr.X enters into a contract with Mr.Y that six months from now he will sell to Y 10 dresses for Rs 4000. The cost of manufacturing for X is only Rs 1000 and he will make a profit of Rs 3000 if the sale is completed.
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Cost (Rs) 1000
Selling price 4000
Profit 3000
However, X fears that Y may not honour his contract six months from now. So he inserts a new clause in the contract that if Y fails to honour the contract he will have to pay a penalty of Rs 1000. And if Y honours the contract X will offer a discount of Rs 1000 as incentive.
Y defaults 1000 (Initial Investment) 1000 (penalty from Mr.Y) - (No gain/loss)
Y honours 3000 (Initial profit) (-1000) discount given to Mr.Y 2000 (Net gain)
As we see above if Mr.Y defaults Mr.X will get a penalty of Rs 1000 but he will recover his initial investment. If Mr.Y honours the contract, Mr.X will still make a profit of Rs 2000. Thus, Mr.X has hedged his risk against default and protected his initial investment. The example explains the concept of hedging. Let us try understanding how one can use hedging in a real life scenario. Stocks carry two types of risk company specific and market risk. While company risk can be minimized by diversifying your portfolio, market risk cannot be diversified but has to be hedged . So how does one measure the market risk? Market risk can be known from Beta. Beta measures the relationship between movement of the index to the movement of the stock. The beta measures the percentage impact on the stock prices for 1% change in the index. Therefore, for a portfolio whose value goes down by 11% when the index goes down by 10%, the beta would be 1.1. When the index increases
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by 10%, the value of the portfolio increases 11%. The idea is to make beta of your portfolio zero to nullify your losses. Hedging involves protecting an existing asset position from future adverse price movements. In order to hedge a position, a market player needs to take an equal and opposite position in the futures market to the one held in the cash market . Every portfolio has a hidden exposure to the index, which is denoted by the beta. Assuming you have a portfolio of Rs 1 million, which has a beta of 1.2, you can factor a complete hedge by selling Rs 1.2 mn of S&P CNX Nifty futures Steps: 1. Determine the beta of the portfolio. If the beta of any stock is not known, it is safe to assume that it is 1. 2. Short sell the index in such a quantum that the gain on a unit decrease in the index would offset the losses on the rest of the portfolio. This is achieved by multiplying the relative volatility of the portfolio by the market value of his holdings. Therefore in the above scenario we have to shortsell 1.2 * 1 million = 1.2 million worth of Nifty. Now let us see the impact on the overall gain/loss that accrues:
Index up 10% Index down 10% Gain/(Loss) in Portfolio Gain/(Loss) in Futures Net Effect Rs 120,000 (Rs 120,000) Nil (Rs 120,000) Rs 120,000 Nil
As we see, that portfolio is completely insulated from any losses arising out of a fall in market sentiment. But as a cost, one has to forego any gains that arise out of improvement in the overall sentiment. Then why does one invest in equities if all the gains will be offset by losses in futures market. The idea is that everyone
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expects his portfolio to outperform the market. Irrespective of whether the market goes up or not, his portfolio value would increase. The same methodology can be applied to a single stock by deriving the beta of the scrip and taking a reverse position in the futures market. Thus, we understand how one can use hedging in the futures market to offset losses in the cash market. 6.3 Speculation Speculators are those who do not have any position on which they enter in futures and options market. They only have a particular view on the market, stock, commodity etc. In short, speculators put their money at risk in the hope of profiting from an anticipated price change. They consider various factors such as demand supply, market positions, open interests, economic fundamentals and other data to take their positions. Illustration: Mr.X is a trader but has no time to track and analyze stocks. However, he fancies his chances in predicting the market trend. So instead of buying different stocks he buys Sensex Futures. On May 1, 2001, he buys 100 Sensex futures @ 3600 on expectations that the index will rise in future. On June 1, 2001, the Sensex rises to 4000 and at that time he sells an equal number of contracts to close out his position. Selling Price : 4000*100 = Rs.4,00,000
Less: Purchase Cost: 3600*100 = Rs.3,60,000 Net gain Rs.40,000
Mr.X has made a profit of Rs.40,000 by taking a call on the future value of the Sensex. However, if the Sensex had fallen he would have made a loss. Similarly, if it
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would have been bearish he could have sold Sensex futures and made a profit from a falling profit. In index futures players can have a long-term view of the market up to atleast 3 months. 6.4 Arbitrage An arbitrageur is basically risk averse. He enters into those contracts were he can earn riskless profits. When markets are imperfect, buying in one market and simultaneously selling in other market gives riskless profit. Arbitrageurs are always in the look out for such imperfections. In the futures market one can take advantages of arbitrage opportunities by buying from lower priced market and selling at the higher priced market. In index futures arbitrage is possible between the spot market and the futures market (NSE has provided a special software for buying all 50 Nifty stocks in the spot market.

Take the case of the NSE Nifty. Assume that Nifty is at 1200 and 3 months Nifty futures is at 1300. The futures price of Nifty futures can be worked out by taking the interest cost of 3 months into account.
If there is a difference then arbitrage opportunity exists.
Let us take the example of single stock to understand the concept better. If Wipro is quoted at Rs.1000 per share and the 3 months futures of Wipro is Rs.1070 then one can purchase Wipro at Rs.1000 in spot by borrowing @ 12% annum for 3 months and sell Wipro futures for 3 months at Rs 1070. Sale = 1070
Cost= 1000+30 = 1030 Arbitrage profit = 40
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These kind of imperfections continue to exist in the markets but one has to be alert to the opportunities as they tend to get exhausted very fast.
6.5 Pricing of Index Futures The index futures are the most popular futures contracts as they can be used in a variety of ways by various participants in the market. How many times have you felt of making risk-less profits by arbitraging between the underlying and futures markets. If so, you need to know the cost-of-carry model to understand the dynamics of pricing that constitute the estimation of fair value of futures. 1. The cost of carry model The cost-of-carry model where the price of the contract is defined as: F=S+C where: F Futures price S Spot price C Holding costs or carry costs If F < S+C or F > S+C, arbitrage opportunities would exist i.e. whenever the futures price moves away from the fair value, there would be chances for arbitrage. If Wipro is quoted at Rs.1000 per share and the 3 months futures of Wipro is Rs.1070 then one can purchase Wipro at Rs.1000 in spot by borrowing @ 12% annum for 3 months and sell Wipro futures for 3 months at Rs 1070.
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Here F=1000+30=1030 and is less than prevailing futures price and hence there are chances of arbitrage. Sale = 1070
Cost= 1000+30 = 1030 Arbitrage profit 40
However, one has to remember that the components of holding cost vary with contracts on different assets. 2. Futures pricing in case of dividend yield We have seen how we have to consider the cost of finance to arrive at the futures index value. However, the cost of finance has to be adjusted for benefits of dividends and interest income. In the case of equity futures, the holding cost is the cost of financing minus the dividend returns. Example: Suppose a stock portfolio has a value of Rs.100 and has an annual dividend yield of 3% which is earned throughout the year and finance rate=10% the fair value of the stock index portfolio after one year will be F= Rs.100 + Rs.100 * (0.10 0.03) Futures price = Rs 107 If the actual futures price of one-year contract is Rs.109. An arbitrageur can buy the stock at Rs.100, borrowing the fund at the rate of 10% and simultaneously sell futures at Rs.109. At the end of the year, the arbitrageur would collect Rs.3 for dividends, deliver the stock portfolio at Rs.109 and repay the loan of Rs.100 and interest of Rs.10. The net profit would be Rs 109 + Rs 3 - Rs 100 - Rs 10 = Rs 2. Thus, we can arrive at the fair value in the case of dividend yield.
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Trading strategies
1. Speculation We have seen earlier that trading in index futures helps in taking a view of the market, hedging, speculation and arbitrage. Now we will see how one can trade in index futures and use forward contracts in each of these instances. Taking a view of the market Have you ever felt that the market would go down on a particular day and feared that your portfolio value would erode? There are two options available Option 1: Sell liquid stocks such as Reliance Option 2: Sell the entire index portfolio The problem in both the above cases is that it would be very cumbersome and costly to sell all the stocks in the index. And in the process one could be vulnerable to company specific risk. So what is the option? The best thing to do is to sell index futures. Illustration: Scenario 1: On July 13, 2001, X feels that the market will rise so he buys 200 Nifties with an expiry date of July 26 at an index price of 1442 costing Rs 2,88,400 (200*1442). On July 21 the Nifty futures have risen to 1520 so he squares off his position at 1520. BABASAB PATIL PROJECT REPORT ON FINANCE 26
X makes a profit of Rs 15,600 (200*78)
Scenario 2: On July 20, 2001, X feels that the market will fall so he sells 200 Nifties with an expiry date of July 26 at an index price of 1523 costing Rs 3,04,600 (200*1523). On July 21 the Nifty futures falls to 1456 so he squares off his position at 1456. X makes a profit of Rs 13,400 (200*67). In the above cases X has profited from speculation i.e. he has wagered in the hope of profiting from an anticipated price change. 2. Hedging Stock index futures contracts offer investors, portfolio managers, mutual funds etc several ways to control risk. The total risk is measured by the variance or standard deviation of its return distribution. A common measure of a stock market risk is the stocks Beta. The Beta of stocks are available on the www.nseindia.com. While hedging the cash position one needs to determine the number of futures contracts to be entered to reduce the risk to the minimum. Have you ever felt that a stock was intrinsically undervalued? That the profits and the quality of the company made it worth a lot more as compared with what the market thinks? Have you ever been a stockpicker and carefully purchased a stock based on a sense that it was worth more than the market price? A person who feels like this takes a long position on the cash market. When doing this, he faces two kinds of risks:
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a. His understanding can be wrong, and the company is really not worth more than the market price or b. The entire market moves against him and generates losses even though the underlying idea was correct. Everyone has to remember that every buy position on a stock is simultaneously a buy position on Nifty. A long position is not a focused play on the valuation of a stock. It carries a long Nifty position along with it, as incidental baggage i.e. a part long position of Nifty. Let us see how one can hedge positions using index futures: X holds HLL worth Rs 9 lakh at Rs 290 per share on Jan1 2008asuming that the beta of HLL is 1.13. How much Nifty futures does X have to sell if the index futures is ruling at 1527? To hedge he needs to sell 9 lakh * 1.13 = Rs 1017000 lakh on the index futures i.e. 666 Nifty futures. On Jan , 2008 the Nifty futures is at 1437 and HLL is at 275. X closes both positions earning Rs 13,389, i.e. his position on HLL drops by Rs 46,551 and his short position on Nifty gains Rs 59,940 (666*90). Therefore, the net gain is 59940-46551 = Rs 13,389. Let us take another example when one has a portfolio of stocks: Suppose you have a portfolio of Rs 10 crore. The beta of the portfolio is 1.19. The portfolio is to be hedged by using Nifty futures contracts. To find out the number of contracts in futures market to neutralise risk . If the index is at 1200 * 200 (market lot) = Rs 2,40,000, The number of contracts to be sold is: a. 1.19*10 crore = 496 contracts 2,40,000
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If you sell more than 496 contracts you are overhedged and sell less than 496 contracts you are underhedged. Thus, we have seen how one can hedge their portfolio against market risk.
3. Margins The margining system is based on the JR Verma Committee
recommendations. The actual margining happens on a daily basis while online position monitoring is done on an intra-day basis. Daily margining is of two types: 1. Initial margins 2. Mark-to-market profit/loss The computation of initial margin on the futures market is done using the concept of Value-at-Risk (VaR). The initial margin amount is large enough to cover a one-day loss that can be encountered on 99% of the days. VaR methodology seeks to measure the amount of value that a portfolio may stand to lose within a certain horizon time period (one day for the clearing corporation) due to potential changes in the underlying asset market price. Initial margin amount computed using VaR is collected up-front. The daily settlement process called "mark-to-market" provides for collection of losses that have already occurred (historic losses) whereas initial margin seeks to safeguard against potential losses on outstanding positions. The markto-market settlement is done in cash. Let us take a hypothetical trading activity of a client of a NSE futures division to demonstrate the margins payments that would occur.

A client purchases 200 units of FUTIDX NIFTY 29JUN2001 at Rs 1500. The initial margin payable as calculated by VaR is 15%.
Total long position = Rs 3,00,000 (200*1500)
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Initial margin (15%) = Rs 45,000 Assuming that the contract will close on Day + 3 the mark-to-market position will look as follows: Position on Day 1
Close Price Loss 1400*200 =2,80,000 20,000 (3,00,0002,80,000) Payment to be made Margin released 3,000 (45,00042,000) Net cash outflow 17,000 (20,0003000) (17,000)
New position on Day 2 Value of new position = 1,400*200= 2,80,000 Margin = 42,000
Close Price Gain 1510*200 =3,02,000 22,000 (3,02,0002,80,000) Payment to be recd Addn Margin 3,300 (45,30042,000) Net cash inflow 18,700 (22,0003300) 18,700
Position on Day 3 Value of new position = 1510*200 = Rs 3,02,000 Margin = Rs 3,300

Close Price Gain 1600*200 =3,20,000 18,000 (3,20,0003,02,000) Payment to be recd 63,300 Net cash inflow 18,000 + 45,300* = 63,300
Margin account* Initial margin = Rs 45,000
Margin released (Day 1) = (-) Rs 3,000 Position on Day 2 Rs 42,000
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Addn margin Total margin in a/c Net gain/loss Day 1 (loss) Day 2 Gain Day 3 Gain Total Gain
= (+) Rs 3,300 Rs 45,300*
= = = =
(Rs 17,000) Rs 18,700 Rs 18,000 Rs 19,700
The client has made a profit of Rs 19,700 at the end of Day 3 and the total cash inflow at the close of trade is Rs 63,300. Settlement of futures contracts: Futures contracts have two types of settlements, the MTM settlement which happens on a continuous basis at the end of each day, and the final settlement which happens on the last trading day of the futures contract.
1. MTM settlement: All futures contracts for each member are marked-to-market(MTM) to the daily settlement price of the relevant futures contract at the end of each day. The profits/losses are computed as the difference between:
The trade price and the days settlement price for contracts executed during the day but not squared up. The previous days settlement price and the current days settlement price for brought forward contracts. The buy price and the sell price for contracts executed during the day and squared up.
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The CMs who have a loss are required to pay the mark-to-market (MTM) loss amount in cash which is in turn passed on to the CMs who have made a MTM profit. This is known as daily mark-to-market settlement. CMs are responsible to collect and settle the daily MTM profits/losses incurred by the TMs and their clients clearing and settling through them. Similarly, TMs are responsible to collect/pay losses/ profits from/to their clients by the next day. The pay-in and pay-out of the mark-to-market settlement are effected on the day following the trade day. In case a futures contract is not traded on a day, or not traded during the last half hour, a theoretical settlement price is computed. 2. Final settlement for futures On the expiry day of the futures contracts, after the close of trading hours, NSCCL marks all positions of a CM to the final settlement price and the resulting profit/loss is settled in cash. Final settlement loss/profit amount is debited/ credited to the relevant CMs clearing bank account on the day following expiry day of the contract. All trades in the futures market are cash settled on a T+1 basis and all positions (buy/sell) which are not closed out will be marked-to-market. The closing price of the index futures will be the daily settlement price and the position will be carried to the next day at the settlement price. The most common way of liquidating an open position is to execute an offsetting futures transaction by which the initial transaction is squared up. The initial buyer liquidates his long position by selling identical futures contract. In index futures the other way of settlement is cash settled at the final settlement. At the end of the contract period the difference between the contract value and closing index value is paid. How to read the futures data sheet? Understanding and deciphering the prices of futures trade is the first challenge for anyone planning to venture in futures trading. Economic dailies and exchange websites www.nseindia.com and www.bseindia.com are some of the sources where BABASAB PATIL PROJECT REPORT ON FINANCE 32
one can look for the daily quotes. Your website has a daily market commentary, which carries end of day derivatives summary along with the quotes. The first step is start tracking the end of day prices. Closing prices, Trading Volumes and Open Interest are the three primary data we carry with Index option quotes. The most important parameter are the actual prices, the high, low, open, close, last traded prices and the intra-day prices and to track them one has to have access to real time prices. The following table shows how futures data will be generally displayed in the business papers daily.
Series First Trade High Low Close Volume (No of contracts) BSXJUN2000 BSXJUL2000 BSXAUG2000 Total 4755 4900 4800 4820 4900 4870 4740 4800 4800 4783.1 4830.8 4835 146 12 2 160 Value (Rs in lakh) 348.70 28.98 4.84 38252 104 10 2 116 No of trades Open interest (No of contracts) 51 2 1 54
Source: BSE
The first column explains the series that is being traded. For e.g. BSXJUN2000 stands for the June Sensex futures contract.
The column on volume indicates that (in case of June series) 146 contracts have been traded in 104 trades.
One contract is equivalent to 50 times the price of the futures, which are traded. For e.g. In case of the June series above, the first trade at 4755 represents one contract valued at 4755 x 50 i.e. Rs.2,37,750/-.
Open interest indicates the total gross outstanding open positions in the market for that particular series. For e.g. Open interest in the June series is 51 contracts. The most useful measure of market activity is Open interest, which is also published by exchanges and used for technical analysis. Open interest indicates the liquidity of a
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market and is the total number of contracts, which are still outstanding in a futures market for a specified futures contract. A futures contract is formed when a buyer and a seller take opposite positions in a transaction. This means that the buyer goes long and the seller goes short. Open interest is calculated by looking at either the total number of outstanding long or short positions not both Open interest is therefore a measure of contracts that have not been matched and closed out. The number of open long contracts must equal exactly the number of open short contracts.
Action Resulting open interest New buyer (long) and new seller (short) Rise Trade to form a new contract. Existing buyer sells and existing seller buys Fall
The old contract is closed. New buyer buys from existing buyer. The No change there is no increase in long Existing buyer closes his position by sellingcontracts being held to new buyer. Existing seller buys from new seller. TheNo change there is no increase in short Existing seller closes his position by buyingcontracts being held from new seller.
Open interest is also used in conjunction with other technical analysis chart patterns and indicators to gauge market signals. The following chart may help with these signals.
Price Open interest Market Strong Warning signal Weak Warning signal
The warning sign indicates that the Open interest is not supporting the price direction.
OPTIONS
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What is an Option? An option is a contract giving the buyer the right, but not the obligation, to buy or sell an underlying asset (a stock or index) at a specific price on or before a certain date (listed options are all for 100 shares of the particular underlying asset). An option is a security, just like a stock or bond, and constitutes a binding contract with strictly defined terms and properties. Listed options have been available since 1973, when the Chicago Board Options Exchange, still the busiest options exchange in the world, first opened. The World With and Without Options Prior to the founding of the CBOE, investors had few choices of where to invest their money; they could either be long or short individual stocks, or they could purchase treasury securities or other bonds. Once the CBOE opened, the listed option industry began, and investors now had a world of investment choices previously unavailable. Options vs. Stocks In order to better understand the benefits of trading options, one must first understand some of the similarities and differences between options and stocks. Similarities: Listed Options are securities, just like stocks. Options trade like stocks, with buyers making bids and sellers making offers. Options are actively traded in a listed market, just like stocks. They can be bought and sold just like any other security.
Differences: Options are derivatives, unlike stocks (i.e, options derive their value from something else, the underlying security). Options have expiration dates, while stocks do not. There is not a fixed number of options, as there are with stock shares available. Stockowners have a share of the company, with voting and dividend rights. Options convey no such rights. BABASAB PATIL PROJECT REPORT ON FINANCE 35
Options Premiums In this case, XYZ represents the option class while May 30 is the option series. All options on company XYZ are in the XYZ option class but there will be many different series. An option Premium is the price of the option. It is the price you pay to purchase the option. For example, an XYZ May 30 Call (thus it is an option to buy Company XYZ stock) may have an option premium of $2. This means that this option costs $200.00. Why? Because most listed options are for 100 shares of stock, and all equity option prices are quoted on a per share basis, so they need to be multiplied times 100. More in-depth pricing concepts will be covered in detail in other sections of the course. Strike Price The Strike (or Exercise) Price is the price at which the underlying security (in this case, XYZ) can be bought or sold as specified in the option contract. For example, with the XYZ May 30 Call, the strike price of 30 means the stock can be bought for $30 per share. Were this the XYZ May 30 Put, it would allow the holder the right to sell the stock at $30 per share. The strike price also helps to identify whether an option is In-the-Money, Atthe-Money, or Out-of-the-Money when compared to the price of the underlying security. You will learn about these terms in another section of the course. Exercising Options People who buy options have a Right, and that is the right to Exercise. For a Call Exercise, Call holders may buy stock at the strike price (from the Call seller). For a Put Exercise, Put holders may sell stock at the strike price (to the Put seller). Neither Call holders nor Put holders are obligated to buy or sell; they simply have the rights to do so, and may choose to Exercise or not to Exercise based upon their own logic. Assignment of Options When an option holder chooses to exercise an option, a process begins to find a writer who is short the same kind of option (i.e., class, strike price and option type).
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Once found, that writer may be Assigned. This means that when buyers exercise, sellers may be chosen to make good on their obligations. For a Call Assignment, Call writers are required to sell stock at the strike price to the Call holder. For a Put Assignment, Put writers are required to buy stock at the strike price from the Put holder. Long Term Investing Given the numerous opportunities that options convey, it is also important to know that there are options available which can be used to implement longer-term strategies (not one, two or three months, but those with holding times of one, two or more years). These are called LEAPS (for Long Term Equity Anticipation Securities), and are yet another alternative that options offer to investors. LEAPS are options with expiration dates of up to three years from the date they are first listed, and are available on a number of individual stocks and indexes. LEAPS have different ticker symbols than short-term options (options with less than nine months until expiration) and, while not available on all stocks, are available on most widely held issues and can be traded just like any other options. 7.2 The Chicago Board Options Exchange The Chicago Board Options Exchange, or CBOE, was the world's first listed options exchange, opened in 1973 by members of the Chicago Board of Trade. Almost half of all listed options trades still occur on CBOE. NOTE: Options also trade now on several smaller exchanges, including the American Stock Exchange (AMEX), the Philadelphia Stock Exchange (PHLX), the Pacific Stock Exchange (PSE) and the International Securities Exchange (ISE).
CBOE: The Competitive Advantage With over 1500 competing market makers trading more than one million options contracts per day, the CBOE is the largest and busiest options exchange in the world. BABASAB PATIL PROJECT REPORT ON FINANCE 37
The members of the Exchange have maintained this stature for over 25 years by constantly providing deep and liquid markets in all options series for all CBOE customers. CBOE Facts The CBOE system works to give you the options you need for your investment strategy, quickly and easily and at the most efficient price. The CBOE offers investors the best options markets, the most efficient support network, and the most intensive insight and most recognized educational division in the industry, the Options Institute. CBOE is the market leader in the options industry, with: Options on more than 1,332 stocks and 41 indices. More than 50,000 series listed Over $25 billion in contract value traded on a typical day Over 1 million options contracts changing hands daily The second largest listed securities market in the U.S., following only the NYSE Professional instructors teaching options trading to over 10,000 people a year The premier portal for options information on the Web,\
7.3 Regulation and Surveillance: Regulation and surveillance are necessary in the options industry in order to protect customers and firms, and respond to customer complaints. CBOE has one of the most technologically advanced and computer-automated measures for regulation and surveillance, which are unparalleled in the options industry. CBOE has the premier Regulatory Division, with staff who constantly monitor trading activity throughout the industry. The Securities and Exchange Commission (SEC) oversees the entire options industry to ensure that the markets serve the public interest.
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Options Clearing Corporation: The formation of the OCC in 1973 as the single, independent, universal clearing agency for all listed options eliminated the problem of credit risk in options trading. Every options Exchange and every brokerage firm who offers its customers the ability to trade options is a member or is associated with a member of the OCC. The OCC stands in the middle of each trade becoming the buyer for all contracts that are sold, and the seller for all contracts that are bought. Thus, the OCC is, in fact, the issuer of all listed options contracts, and is registered as such with the SEC. 7.5 Options Market Participants Contrary to some beliefs, the single greatest population of CBOE users are not huge financial institutions, but public investors, just like you. Over 65% of the Exchange's business comes from them. However, other participants in the financial marketplace also use options to enhance their performance, including: Mutual Funds Pension Plans Hedge Funds Endowments Corporate Treasurers
Stock markets by their very nature are fickle. While fortunes can be made in a jiffy more often than not the scenario is the reverse. Investing in stocks has two sides to it a) Unlimited profit potential from any upside (remember Infosys, HFCL etc) or b) a downside which could make you a pauper. Derivative products are structured precisely for this reason -- to curtail the risk exposure of an investor. Index futures and stock options are instruments that enable you to hedge your portfolio or open positions in the market. Option contracts allow you to run your profits while restricting your downside risk. Apart from risk containment, options can be used for speculation and investors can create a wide range of potential profit scenarios.
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Option, as the word suggests, is a choice given to the investor to either honour the contract; or if he chooses not to walk away from the contract. To begin, there are two kinds of options: Call Options and Put Options. Call options Call options give the taker the right, but not the obligation, to buy the underlying shares at a predetermined price, on or before a predetermined date. Illustration 1: Raj purchases 1 Satyam Computer (SATCOM) AUG 150 Call --Premium 8 This contract allows Raj to buy 100 shares of SATCOM at Rs 150 per share at any time between the current date and the end of next August. For this privilege, Raj pays a fee of Rs 800 (Rs eight a share for 100 shares). The buyer of a call has purchased the right to buy and for that he pays a premium. Now let us see how one can profit from buying an option. Sam purchases a December call option at Rs 40 for a premium of Rs 15. That is he has purchased the right to buy that share for Rs 40 in December. If the stock rises above Rs 55 (40+15) he will break even and he will start making a profit. Suppose the stock does not rise and instead falls he will choose not to exercise the option and forego the premium of Rs 15 and thus limiting his loss to Rs 15. Let us take another example of a call option on the Nifty to understand the concept better. Nifty is at 1310. The following are Nifty options traded at following quotes.
Option contract Dec Nifty
Strike price 1325 1345 1325 1345
Call premium Rs.6,000 Rs.2,000 Rs.4,500 Rs.5000
Jan Nifty
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A trader is of the view that the index will go up to 1400 in Jan 2008 but does not want to take the risk of prices going down. Therefore, he buys 10 options of Jan contracts at 1345. He pays a premium for buying calls (the right to buy the contract) for 500*10= Rs.5,000/-. In Jan 2008 the Nifty index goes up to 1365. He sells the options or exercises the option and takes the difference in spot index price which is (1365-1345) * 200 (market lot) = 4000 per contract. Total profit = 40,000/- (4,000*10). He had paid Rs.5,000/- premium for buying the call option. So he earns by buying call option is Rs.35,000/- (40,000-5000). If the index falls below 1345 the trader will not exercise his right and will opt to forego his premium of Rs.5,000. So, in the event the index falls further his loss is limited to the premium he paid upfront, but the profit potential is unlimited. Call Options-Long and Short Positions When you expect prices to rise, then you take a long position by buying calls. You are bullish. When you expect prices to fall, then you take a short position by selling calls. You are bearish.
Put Options : A Put Option gives the holder of the right to sell a specific number of shares of an agreed security at a fixed price for a period of time. eg: Sam purchases 1 INFTEC (Infosys Technologies) AUG 3500 Put --Premium 200. This contract allows Sam to sell 100 shares INFTEC at Rs 3500 per share at any time between the current date and the end of August. To have this privilege, Sam pays a premium of Rs 20,000 (Rs 200 a share for 100 shares). The buyer of a put has purchased a right to sell. The owner of a put option has the right to sell.
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Illustration 2: Raj is of the view that the a stock is overpriced and will fall in future, but he does not want to take the risk in the event of price rising so purchases a put option at Rs 70 on X. By purchasing the put option Raj has the right to sell the stock at Rs 70 but he has to pay a fee of Rs 15 (premium). So he will breakeven only after the stock falls below Rs 55 (70-15) and will start making profit if the stock falls below Rs 55. Illustration 3: An investor on Dec 15 is of the view that Wipro is overpriced and will fall in future but does not want to take the risk in the event the prices rise. So he purchases a Put option on Wipro. Quotes are as under: Spot Rs.1040 Jan Put at 1050 Rs.10 Jan Put at 1070 Rs.30 He purchases 1000 Wipro Put at strike price 1070 at Put price of Rs.30/-. He pays Rs.30,000/- as Put premium. His position in following price position is discussed below. 1. Jan Spot price of Wipro = 1020 2. Jan Spot price of Wipro = 1080 In the first situation the investor is having the right to sell 1000 Wipro shares at Rs.1,070/- the price of which is Rs.1020/-. By exercising the option he earns Rs. (1070-1020) = Rs 50 per Put, which totals Rs 50,000/-. His net income is Rs (5000030000) = Rs 20,000.
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In the second price situation, the price is more in the spot market, so the investor will not sell at a lower price by exercising the Put. He will have to allow the Put option to expire unexercised. He looses the premium paid Rs 30,000. Put Options-Long and Short Positions When you expect prices to fall, then you take a long position by buying Puts. You are bearish. When you expect prices to rise, then you take a short position by selling Puts. You are bullish.
If you expect a fall in price(Bearish) If you expect a rise in price (Bullish)
CALL OPTIONS Short Long
PUT OPTIONS Long Short
SUMMARY:
CALL OPTION BUYER Pays premium Right to exercise and buy the shares Profits from rising prices Limited losses, Potentially unlimited gain
CALL OPTION WRITER (Seller) Receives premium Obligation to sell shares if exercised Profits from falling prices or
remaining neutral Potentially unlimited losses, limited
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gain
PUT OPTION BUYER Pays premium Right to exercise and sell shares Profits from falling prices Limited losses, Potentially unlimited gain
PUT OPTION WRITER (Seller) Receives premium Obligation to buy shares if exercised Profits from rising prices or
remaining neutral Potentially unlimited losses, limited gain
Option styles Settlement of options is based on the expiry date. However, there are three basic styles of options you will encounter which affect settlement. The styles have geographical names, which have nothing to do with the location where a contract is agreed! The styles are: European: These options give the holder the right, but not the obligation, to buy or sell the underlying instrument only on the expiry date. This means that the option cannot be exercised early. Settlement is based on a particular strike price at expiration. Currently, in India only index options are European in nature. eg: Sam purchases 1 NIFTY AUG 1110 Call --Premium 20. The exchange will settle the contract on the last Thursday of August. Since there are no shares for the underlying, the contract is cash settled. American: These options give the holder the right, but not the obligation, to buy or sell the underlying instrument on or before the expiry date. This means that the option can be exercised early. Settlement is based on a particular strike price at expiration.
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Options in stocks that have been recently launched in the Indian market are "American Options". eg: Sam purchases 1 ACC SEP 145 Call --Premium 12 Here Sam can close the contract any time from the current date till the expiration date, which is the last Thursday of September. American style options tend to be more expensive than European style because they offer greater flexibility to the buyer. Option Class and Series Generally, for each underlying, there are a number of options available: For this reason, we have the terms "class" and "series". An option "class" refers to all options of the same type (call or put) and style (American or European) that also have the same underlying. eg: All Nifty call options are referred to as one class. An option series refers to all options that are identical: they are the same type, have the same underlying, the same expiration date and the same exercise price.
Calls . Wipro 1300 1400 1500 Jan 45 35 20 Feb 60 45 42 Mar 75 65 48
Puts Jan 15 25 30 Feb 20 28 40 Mar 28 35 55
eg: Wipro JUL 1300 refers to one series and trades take place at different premiums All calls are of the same option type. Similarly, all puts are of the same option type. Options of the same type that are also in the same class are said to be of the same class. Options of the same class and with the same exercise price and the same expiration date are said to be of the same series
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Pricing of options Options are used as risk management tools and the valuation or pricing of the instruments is a careful balance of market factors. There are four major factors affecting the Option premium:

Price of Underlying Time to Expiry Exercise Price Time to Maturity Volatility of the Underlying
And two less important factors:

Short-Term Interest Rates Dividends
7.11 Review of Options Pricing Factors 1. The Intrinsic Value of an Option The intrinsic value of an option is defined as the amount by which an option is in-the-money, or the immediate exercise value of the option when the underlying position is marked-to-market. For a call option: Intrinsic Value = Spot Price - Strike Price For a put option: Intrinsic Value = Strike Price - Spot Price The intrinsic value of an option must be positive or zero. It cannot be negative. For a call option, the strike price must be less than the price of the underlying asset for the call to have an intrinsic value greater than 0. For a put option, the strike price must be greater than the underlying asset price for it to have intrinsic value. Price of underlying
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The premium is affected by the price movements in the underlying instrument. For Call options the right to buy the underlying at a fixed strike price as the underlying price rises so does its premium. As the underlying price falls so does the cost of the option premium. For Put options the right to sell the underlying at a fixed strike price as the underlying price rises, the premium falls; as the underlying price falls the premium cost rises. The following chart summarizes the above for Calls and Puts.
Option Call Put
Underlying price
Premium cost
2. The Time Value of an Option Generally, the longer the time remaining until an options expiration, the higher its premium will be. This is because the longer an options lifetime, greater is the possibility that the underlying share price might move so as to make the option inthe-money. All other factors affecting an options price remaining the same, the time value portion of an options premium will decrease (or decay) with the passage of time. Note: This time decay increases rapidly in the last several weeks of an options life. When an option expires in-the-money, it is generally worth only its intrinsic value.
Option Call Put
Time to expiry
Premium cost
3. Volatility Volatility is the tendency of the underlying securitys market price to fluctuate either up or down. It reflects a price changes magnitude; it does not imply a bias
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toward price movement in one direction or the other. Thus, it is a major factor in determining an options premium. The higher the volatility of the underlying stock, the higher the premium because there is a greater possibility that the option will move in-the-money. Generally, as the volatility of an under-lying stock increases, the premiums of both calls and puts overlying that stock increase, and vice versa. Higher volatility=Higher premium Lower volatility = Lower premium 4. Interest rates In general interest rates have the least influence on options and equate approximately to the cost of carry of a futures contract. If the size of the options contract is very large, then this factor may take on some importance. All other factors being equal as interest rates rise, premium costs fall and vice versa. The relationship can be thought of as an opportunity cost. In order to buy an option, the buyer must either borrow funds or use funds on deposit. Either way the buyer incurs an interest rate cost. If interest rates are rising, then the opportunity cost of buying options increases and to compensate the buyer premium costs fall. Why should the buyer be compensated? Because the option writer receiving the premium can place the funds on deposit and receive more interest than was previously anticipated. The situation is reversed when interest rates fall premiums rise. This time it is the writer who needs to be compensated.
STRATEGIES
Bull Market Strategies a. Calls in a Bullish Strategy An investor with a bullish market outlook should buy call options. If you expect the market price of the underlying asset to rise, then you would rather have the right to purchase at a specified price and sell later at a higher price than have the obligation to deliver later at a higher price. BABASAB PATIL PROJECT REPORT ON FINANCE 48
The investor's profit potential of buying a call option is unlimited. The investor's profit is the market price less the exercise price less the premium. The greater the increase in price of the underlying, the greater the investor's profit. The investor's potential loss is limited. Even if the market takes a drastic decline in price levels, the holder of a call is under no obligation to exercise the option. He may let the option expire worthless. The investor breaks even when the market price equals the exercise price plus the premium. An increase in volatility will increase the value of your call and increase your return. Because of the increased likelihood that the option will become in- the-money, an increase in the underlying volatility (before expiration), will increase the value of a long options position. As an option holder, your return will also increase. A simple example will illustrate the above: Suppose there is a call option with a strike price of Rs.2000 and the option premium is Rs.100. The option will be exercised only if the value of the underlying is greater than Rs.2000 (the strike price). If the buyer exercises the call at Rs.2200 then his gain will be Rs.200. However, this would not be his actual gain for that he will have to deduct the Rs.200 (premium) he has paid. The profit can be derived as follows Profit Profit = = Market Market price price Exercise Strike price price Premium Premium.
2200 2000 100 = Rs.100 b. Puts in a Bullish Strategy An investor with a bullish market outlook can also go short on a Put option. Basically, an investor anticipating a bull market could write Put options. If the market price increases and puts become out-of-the-money, investors with long put positions will let their options expire worthless. BABASAB PATIL PROJECT REPORT ON FINANCE 49
By writing Puts, profit potential is limited. A Put writer profits when the price of the underlying asset increases and the option expires worthless. The maximum profit is limited to the premium received. However, the potential loss is unlimited. Because a short put position holder has an obligation to purchase if exercised. He will be exposed to potentially large losses if the market moves against his position and declines. The break-even point occurs when the market price equals the exercise price: minus the premium. At any price less than the exercise price minus the premium, the investor loses money on the transaction. At higher prices, his option is profitable. An increase in volatility will increase the value of your put and decrease your return. As an option writer, the higher price you will be forced to pay in order to buy back the option at a later date , lower is the return. Bullish Call Spread Strategies A vertical call spread is the simultaneous purchase and sale of identical call options but with different exercise prices. To "buy a call spread" is to purchase a call with a lower exercise price and to write a call with a higher exercise price. The trader pays a net premium for the position. To "sell a call spread" is the opposite, here the trader buys a call with a higher exercise price and writes a call with a lower exercise price, receiving a net premium for the position. An investor with a bullish market outlook should buy a call spread. The "Bull Call Spread" allows the investor to participate to a limited extent in a bull market, while at the same time limiting risk exposure. To put on a bull spread, the trader needs to buy the lower strike call and sell the higher strike call. The combination of these two options will result in a bought
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spread. The cost of Putting on this position will be the difference between the premium paid for the low strike call and the premium received for the high strike call. The investor's profit potential is limited. When both calls are in-the-money, both will be exercised and the maximum profit will be realised. The investor delivers on his short call and receives a higher price than he is paid for receiving delivery on his long call. The investors's potential loss is limited. At the most, the investor can lose is the net premium. He pays a higher premium for the lower exercise price call than he receives for writing the higher exercise price call. The investor breaks even when the market price equals the lower exercise price plus the net premium. At the most, an investor can lose is the net premium paid. To recover the premium, the market price must be as great as the lower exercise price plus the net premium. An example of a Bullish call spread: Let's assume that the cash price of a scrip is Rs.100 and you buy a November call option with a strike price of Rs.90 and pay a premium of Rs.14. At the same time you sell another November call option on a scrip with a strike price of Rs.110 and receive a premium of Rs.4. Here you are buying a lower strike price option and selling a higher strike price option. This would result in a net outflow of Rs.10 at the time of establishing the spread. Now let us look at the fundamental reason for this position. Since this is a bullish strategy, the first position established in the spread is the long lower strike price call option with unlimited profit potential. At the same time to reduce the cost of puchase of the long position a short position at a higher call strike price is established. While this not only reduces the outflow in terms of premium but his profit potential as well as risk is limited. Based on the above figures the maximum profit, maximum loss and breakeven point of this spread would be as follows:
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Maximum profit = Higher strike price - Lower strike price - Net premium paid = 110 - 90 - 10 = 10 Maximum Loss = Lower strike premium - Higher strike premium = 14 - 4 = 10 Breakeven Price = Lower strike price + Net premium paid = 90 + 10 = 100 Bullish Put Spread Strategies A vertical Put spread is the simultaneous purchase and sale of identical Put options but with different exercise prices. To "buy a put spread" is to purchase a Put with a higher exercise price and to write a Put with a lower exercise price. The trader pays a net premium for the position. To "sell a put spread" is the opposite: the trader buys a Put with a lower exercise price and writes a put with a higher exercise price, receiving a net premium for the position. An investor with a bullish market outlook should sell a Put spread. The "vertical bull put spread" allows the investor to participate to a limited extent in a bull market, while at the same time limiting risk exposure. To put on a bull spread, a trader sells the higher strike put and buys the lower strikeput. The bull spread can be created by buying the lower strike and selling the higher strike of either calls or put. The difference between the premiums paid and received makes up one leg of the spread.
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The investor's profit potential is limited. When the market price reaches or exceeds the higher exercise price, both options will be out-of-the-money and will expire worthless. The trader will realize his maximum profit, the net premium The investor's potential loss is also limited. If the market falls, the options will be in-the-money. The puts will offset one another, but at different exercise prices. The investor breaks-even when the market price equals the lower exercise price less the net premium. The investor achieves maximum profit i.e the premium received, when the market price moves up beyond the higher exercise price (both puts are then worthless). An example of a bullish put spread. Lets us assume that the cash price of the scrip is Rs.100. You now buy a November put option on a scrip with a strike price of Rs.90 at a premium of Rs.5 and sell a put option with a strike price of Rs.110 at a premium of Rs.15. The first position is a short put at a higher strike price. This has resulted in some inflow in terms of premium. But here the trader is worried about risk and so caps his risk by buying another put option at the lower strike price. As such, a part of the premium received goes off and the ultimate position has limited risk and limited profit potential. Based on the above figures the maximum profit, maximum loss and breakeven point of this spread would be as follows: Maximum profit = Net option premium income or net credit = 15 - 5 = 10 Maximum loss = Higher strike price - Lower strike price - Net premium received = 110 - 90 - 10 = 10 Breakeven Price = Higher Strike price - Net premium income = 110 - 10 = 100
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2. Bear Market Strategies a. Puts in a Bearish Strategy: When you purchase a put you are long and want the market to fall. A put option is a bearish position. It will increase in value if the market falls. An investor with a bearish market outlook shall buy put options. By purchasing put options, the trader has the right to choose whether to sell the underlying asset at the exercise price. In a falling market, this choice is preferable to being obligated to buy the underlying at a price higher. An investor's profit potential is practically unlimited. The higher the fall in price of the underlying asset, higher the profits. The investor's potential loss is limited. If the price of the underlying asset rises instead of falling as the investor has anticipated, he may let the option expire worthless. At the most, he may lose the premium for the option. The trader's breakeven point is the exercise price minus the premium. To profit, the market price must be below the exercise price. Since the trader has paid a premium he must recover the premium he paid for the option. An increase in volatility will increase the value of your put and increase your return. An increase in volatility will make it more likely that the price of the underlying instrument will move. This increases the value of the option. b. Calls in a Bearish Strategy: Another option for a bearish investor is to go short on a call with the intent to purchase it back in the future. By selling a call, you have a net short position and needs to be bought back before expiration and cancel out your position. For this an investor needs to write a call option. If the market price falls, long call holders will let their out-of-the-money options expire worthless, because they could purchase the underlying asset at the lower market price. The investor's profit potential is limited because the trader's maximum profit is limited to the premium received for writing the option.
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Here the loss potential is unlimited because a short call position holder has an obligation to sell if exercised, he will be exposed to potentially large losses if the market rises against his position. The investor breaks even when the market price equals the exercise price: plus the premium. At any price greater than the exercise price plus the premium, the trader is losing money. When the market price equals the exercise price plus the premium, the trader breaks even. An increase in volatility will increase the value of your call and decrease your return. When the option writer has to buy back the option in order to cancel out his position, he will be forced to pay a higher price due to the increased value of the calls. Bearish Put Spread Strategies A vertical put spread is the simultaneous purchase and sale of identical put options but with different exercise prices. To "buy a put spread" is to purchase a put with a higher exercise price and to write a put with a lower exercise price. The trader pays a net premium for the position. To "sell a put spread" is the opposite. The trader buys a put with a lower exercise price and writes a put with a higher exercise price, receiving a net premium for the position. To put on a bear put spread you buy the higher strike put and sell the lower strike put. You sell the lower strike and buy the higher strike of either calls or puts to set up a bear spread. An investor with a bearish market outlook should: buy a put spread. The "Bear Put Spread" allows the investor to participate to a limited extent in a bear market, while at the same time limiting risk exposure. The investor's profit potential is limited. When the market price falls to or below the lower exercise price, both options will be in-the-money and the trader will realize his maximum profit when he recovers the net premium paid for the options.
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The investor's potential loss is limited. The trader has offsetting positions at different exercise prices. If the market rises rather than falls, the options will be outof-the-money and expire worthless. Since the trader has paid a net premium The investor breaks even when the market price equals the higher exercise price less the net premium. For the strategy to be profitable, the market price must fall. When the market price falls to the high exercise price less the net premium, the trader breaks even. When the market falls beyond this point, the trader profits. An example of a bearish put spread. Lets assume that the cash price of the scrip is Rs.100. You buy a November put option on a scrip with a strike price of Rs.110 at a premium of Rs.15 and sell a put option with a strike price of Rs.90 at a premium of Rs.5. In this bearish position the put is taken as long on a higher strike price put with the outgo of some premium. This position has huge profit potential on downside. If the trader may recover a part of the premium paid by him by writing a lower strike price put option. The resulting position is a mildly bearish position with limited risk and limited profit profile. Though the trader has reduced the cost of taking a bearish position, he has also capped the profit potential as well. The maximum profit, maximum loss and breakeven point of this spread would be as follows: Maximum profit = Higher strike price option - Lower strike price option - Net premium paid = 110 - 90 - 10 = 10 Maximum loss = Net premium paid = 15 - 5 = 10 Breakeven Price = Higher strike price - Net premium paid = 110 - 10 = 100
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Bearish Call Spread Strategies A vertical call spread is the simultaneous purchase and sale of identical call options but with different exercise prices. To "buy a call spread" is to purchase a call with a lower exercise price and to write a call with a higher exercise price. The trader pays a net premium for the position. To "sell a call spread" is the opposite: the trader buys a call with a higher exercise price and writes a call with a lower exercise price, receiving a net premium for the position. To put on a bear call spread you sell the lower strike call and buy the higher strike call. An investor sells the lower strike and buys the higher strike of either calls or puts to put on a bear spread. An investor with a bearish market outlook should: sell a call spread. The "Bear Call Spread" allows the investor to participate to a limited extent in a bear market, while at the same time limiting risk exposure. The investor's profit potential is limited. When the market price falls to the lower exercise price, both out-of-the-money options will expire worthless. The maximum profit that the trader can realize is the net premium: The premium he receives for the call at the higher exercise price. Here the investor's potential loss is limited. If the market rises, the options will offset one another. At any price greater than the high exercise price, the maximum loss will equal high exercise price minus low exercise price minus net premium. The investor breaks even when the market price equals the lower exercise price plus the net premium. The strategy becomes profitable as the market price declines. Since the trader is receiving a net premium, the market price does not have to fall as low as the lower exercise price to breakeven. An example of a bearish call spread. BABASAB PATIL PROJECT REPORT ON FINANCE 57
Let us assume that the cash price of the scrip is Rs 100. You now buy a November call option on a scrip with a strike price of Rs 110 at a premium of Rs 5 and sell a call option with a strike price of Rs 90 at a premium of Rs 15. In this spread you have to buy a higher strike price call option and sell a lower strike price option. As the low strike price option is more expensive than the higher strike price option, it is a net credit startegy. The final position is left with limited risk and limited profit. The maximum profit, maximum loss and breakeven point of this spread would be as follows: Maximum profit = Net premium received = 15 - 5 = 10 Maximum loss = Higher strike price option - Lower strike price option Net premium received = 110 - 90 - 10 = 10 Breakeven Price = Lower strike price + Net premium paid = 90 + 10 = 100 Key Regulations In India we have two premier exchanges The National Stock Exchange of India (NSE) and The Bombay Stock Exchange (BSE) which offer options trading on stock indices as well as individual securities. Options on stock indices are European in kind and settled only on the last of expiration of the underlying. NSE offers index options trading on the NSE Fifty index called the Nifty. While BSE offers index options on the countrys widely used index Sensex, which consists of 30 stocks. Options on individual securities are American. The number of stock options contracts to be traded on the exchanges will be based on the list of securities as
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specified by Securities and Exchange Board of India (SEBI). Additions/deletions in the list of securities eligible on which options contracts shall be made available shall be notified from time to time. Underlying: Underlying for the options on individual securities contracts shall be the underlying security available for trading in the capital market segment of the exchange. Security descriptor: The security descriptor for the options on individual securities shall be:

Market type - N Instrument type - OPTSTK Underlying - Underlying security Expiry date - Date of contract expiry Option type - CA/PA Exercise style - American Premium Settlement method: Premium Settled; CA - Call American PA - Put American.
Trading cycle: The contract cycle and availability of strike prices for options contracts on individual securities shall be as follows: Options on individual securities contracts will have a maximum of threemonth trading cycle. New contracts will be introduced on the trading day following the expiry of the near month contract. On expiry of the near month contract, new contract shall be introduced at new strike prices for both call and put options, on the trading day following the expiry of the near month contract. (See Index futures learning centre for further reading) Strike price intervals: The exchange shall provide a minimum of five strike prices for every option type (i.e call and put) during the trading month. There shall be two contracts in-the-money (ITM), two contracts out-of-the-money (OTM) and one
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contract at-the-money (ATM). The strike price interval for options on individual securities is given in the accompanying table. New contracts with new strike prices for existing expiration date will be introduced for trading on the next working day based on the previous day's underlying close values and as and when required. In order to fix on the at-the-money strike price for options on individual securities contracts the closing underlying value shall be rounded off to the nearest multiplier of the strike price interval. The in-the-money strike price and the out-of-the-money strike price shall be based on the at-the-money strike price interval. Expiry day: Options contracts on individual securities as well as index options shall expire on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts shall expire on the previous trading day. Order type: Regular lot order, stop loss order, immediate or cancel, good till day, good till cancelled, good till date and spread order. Good till cancelled (GTC) orders shall be cancelled at the end of the period of 7 calendar days from the date of entering an order. Permitted lot size: The value of the option contracts on individual securities shall not be less than Rs.2 lakh at the time of its introduction. The permitted lot size for the options contracts on individual securities shall be in multiples of 100 and fractions if any, shall be rounded off to the next higher multiple of 100. Price steps: The price steps in respect of all options contracts admitted to dealings on the exchange shall be Re 0.05. Quantity freeze: Orders which may come to the exchange as a quantity freeze shall be the lesser of the following: 1 per cent of the market wide position limit stipulated of options on individual securities as given in (h) below or Notional value of the contract of around Rs.5 crore. In respect of such orders, which have come under quantity freeze, the member shall be required to confirm to the exchange that there is no inadvertent error in the order entry and that the order is genuine. On such
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confirmation, the exchange at its discretion may approve such order subject to availability of turnover/exposure limits, etc. Base price: Base price of the options contracts on introduction of new contracts shall be the theoretical value of the options contract arrived at based on Black-Scholes model of calculation of options premiums. The base price of the contracts on subsequent trading days will be the daily close price of the options contracts. However in such of those contracts where orders could not be placed because of application of price ranges, the bases prices may be modified at the discretion of the exchange and intimated to the members. Price ranges: There will be no day minimum/maximum price ranges applicable for the options contract. The operating ranges and day minimum/maximum ranges for options contract shall be kept at 99 per cent of the base price. In view of this the members will not be able to place orders at prices which are beyond 99 per cent of the base price. The base prices for option contracts may be modified, at the discretion of the exchange, based on the request received from trading members as mentioned above. Exposure limits: Gross open positions of a member at any point of time shall not exceed the exposure limit as detailed hereunder:

Index Options: Exposure Limit shall be 33.33 times the liquid networth. Option contracts on individual Securities: Exposure Limit shall be 20 times the liquid networth.
Memberwise position limit: When the open position of a Clearing Member, Trading Member or Custodial Participant exceeds 15 per cent of the total open interest of the market or Rs 100 crore, whichever is higher, in all the option contracts on the same underlying, at any time, including during trading hours. For option contracts on individual securities, open interest shall be equivalent to the open positions multiplied by the notional value. Notional Value shall be the previous
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day's closing price of the underlying security or such other price as may be specified from time to time. Market wide position limits: Market wide position limits for option contracts on individual securities shall be lower of: *20 times the average number of shares traded daily, during the previous calendar month, in the relevant underlying security in the underlying segment of the relevant exchange or, 10 per cent of the number of shares held by non-promoters in the relevant underlying security i.e. 10 per cent of the free float in terms of the number of shares of a company. The relevant authority shall specify the market wide position limits once every month, on the expiration day of the near month contract, which shall be applicable till the expiry of the subsequent month contract. Exercise settlement: Exercise type shall be American and final settlement in respect of options on individual securities contracts shall be cash settled for an initial period of 6 months and as per the provisions of National Securities Clearing Corporation Ltd (NSCCL) as may be stipulated from time to time. Reading Stock Option Tables In India, option tables published in business newspapers and is fairly similar to the regular stock tables. The following is the format of the options table published in Indian business news papers:
NIFTY OPTIONS Contracts RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE Exp.Date 7/26/01 7/26/01 7/26/01 7/26/01 7/26/01 Str.Price 360 360 380 380 340 Opt.Type CA PA CA PA CA Open 3 29 1 35 8 High 3 39 1 40 9 Low 2 29 1 35 6 Trd.Qty 4200 1200 1200 1200 11400 No.of.Cont. 7 2 2 2 19 Trd.Value 1512000 432000 456000 456000 3876000
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RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE RELIANCE
7/26/01 7/26/01 7/26/01 8/30/01 8/30/01 8/30/01 7/26/01 7/26/01 7/26/01
340 320 320 360 340 320 300 300 280
PA CA PA PA CA PA CA PA CA
10 22 4 31 15 10 38 2 59
14 24 7 35 15 10 38 2 60
10 16 2 31 15 10 38 2 53
13800 11400 29400 1200 600 600 600 1200 1800
23 19 49 2 1 1 1 2 3
4692000 3648000 9408000 432000 204000 192000 180000 360000 504000
The first column shows the contract that is being traded i.e Reliance. The second column displays the date on which the contract will expire i.e. the expiry date is the last Thursday of the month. Call options-American are depicted as 'CA' and Put options-American as'PA'. The Open, High, Low, Close columns display the traded premium rates.
Advantages of option trading 1. Risk management: Put options allow investors holding shares to hedge against a possible fall in their value. This can be considered similar to taking out insurance against a fall in the share price. 2. Time to decide: By taking a call option the purchase price for the shares is locked in. This gives the call option holder until the Expiry Day to decide whether or not to exercise the option and buy the shares. Likewise the taker of a put option has time to decide whether or not to sell the shares.
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3. Speculation: The ease of trading in and out of an option position makes it possible to trade options with no intention of ever exercising them. If an investor expects the market to rise, they may decide to buy call options. If expecting a fall, they may decide to buy put options. Either way the holder can sell the option prior to expiry to take a profit or limit a loss. Trading options has a lower cost than shares, as there is no stamp duty payable unless and until options are exercised. 4. Leverage: Leverage provides the potential to make a higher return from a smaller initial outlay than investing directly. However, leverage usually involves more risks than a direct investment in the underlying shares. Trading in options can allow investors to benefit from a change in the price of the share without having to pay the full price of the share. We can see below how one can leverage ones position by just paying the premium.
Bought on Oct 15 Sold on Dec 15 Profit ROI (Not annualized)
Option Premium Rs 380 Rs 670 Rs 290 76.3%
Stock Rs 4000 Rs 4500 Rs 500 12.5%
5. Income generation: Shareholders can earn extra income over and above dividends by writing call options against their shares. By writing an option they receive the option premium upfront. While they get to keep the option premium, there is a possibility that they could be exercised against and have to deliver their shares to the taker at the exercise price. 6. Strategies: By combining different options, investors can create a wide range of potential profit scenarios. To find out more about options strategies read the module on trading strategies.
Settlement of options contracts

Options contracts have three types of settlements, daily premium settlement, exercise settlement, interim exercise settlement in the case of option contracts on securities and final settlement.
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1. Daily premium settlement: Buyer of an option is obligated to pay the

premium towards the options purchased by him. Similarly, the seller of an option is entitled to receive the premium for the option sold by him. The premium payable amount and the premium receivable amount are netted to compute the net premium payable or receivable amount for each client for each option contract.
2. Exercise settlement: Although most option buyers and sellers close out their
options positions by an offsetting closing transaction, an understanding of exercise can help an option buyer determine whether exercise might be more advantageous than an offsetting sale of the option. There is always a possibility of the option seller being assigned an exercise. Once an exercise of an option has been assigned to an option seller, the option seller is bound to fulfill his obligation (meaning, pay the cash settlement amount in the case of a cash-settled option) even though he may not yet have been notified of the assignment.
3. Interim exercise settlement: Interim exercise settlement takes place only for
option contracts on securities. An investor can exercise his in-the-money options at any time during trading hours, through his trading member. Interim exercise settlement is effected for such options at the close of the trading hours, on the day of exercise. Valid exercised option contracts are assigned to short positions in the option contract with the same series (i.e. having the same underlying, same expiry date and same strike price), on a random basis, at the client level. The CM who has exercised the option receives the exercise settlement value per unit of the option from the CM who has been assigned the option contract.
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CLEARING AND SETTLEMENT
National Securities Clearing Corporation Limited (NSCCL) undertakes clearing and settlement of all trades executed on the futures and options (F&O) segment of the NSE. It also acts as legal counterparty to all trades on the F&O segment and guarantees their financial settlement.
Clearing entities
Clearing and settlement activities in the F&O segment are undertaken by NSCCL with the help of the following entities:
Clearing members
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In the F&O segment, some members, called self clearing members, clear and settle their trades executed by them only either on their own account or on account of their clients. Some others, called trading membercumclearing member, clear and settle their own trades as well as trades of other trading members(TMs). Besides, there is a special category of members, called professional clearing members (PCM) who clear and settle trades executed by TMs. The members clearing their own trades and trades of others, and the PCMs are required to bring in additional security deposits in respect of every TM whose trades they undertake to clear and settle.
Clearing banks
Funds settlement takes place through clearing banks. For the purpose of settlement all clearing members are required to open a separate bank account with NSCCL designated clearing bank for F&O segment. The Clearing and Settlement process comprises of the following three main activities: 1. Clearing 2. Settlement 3. Risk Management
Risk Management
NSCCL has developed a comprehensive risk containment mechanism for the F&O segment. The salient features of risk containment mechanism on the F&O segment are: The financial soundness of the members is the key to risk management. Therefore, the requirements for membership in terms of capital adequacy (net worth, security deposits) are quite stringent. NSCCL charges an upfront initial margin for all the open positions of a CM. It specifies the initial margin requirements for each futures/options contract on a daily basis. It also follows value-at-risk(VaR) based margining through SPAN. The CM in turn collects the initial margin from the TMs and their respective clients. The open positions of the members are marked to market based on contract settlement price for each contract. The difference is settled in cash on a T+1 basis.
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NSCCLs on-line position monitoring system monitors a CMs open positions on a real-time basis. Limits are set for each CM based on his capital deposits. The on-line position monitoring system generates alerts whenever a CM reaches a position limit set up by NSCCL. NSCCL monitors the CMs for MTM value violation, while TMs are monitored for contract-wise position limit violation. CMs are provided a trading terminal for the purpose of monitoring the open positions of all the TMs clearing and settling through him. A CM may set exposure limits for a TM clearing and settling through him. NSCCL assists the CM to monitor the intra-day exposure limits set up by a CM and whenever a TM exceed the limits, it stops that particular TM from further trading. A member is alerted of his position to enable him to adjust his exposure or bring in additional capital. Position violations result in withdrawal of trading facility for all TMs of a CM in case of a violation by the CM. A separate settlement guarantee fund for this segment has been created out of the capital of members. The fund had a balance of Rs. 648 crore at the end of March 2002. The most critical component of risk containment mechanism for F&O segment is the margining system and on-line position monitoring. The actual position monitoring and margining is carried out online through Parallel Risk Management System (PRISM). PRISM uses SPAN(r) (Standard Portfolio Analysis of Risk) system for the purpose of computation of on-line margins, based on the parameters defined by SEBI.
NSESPAN
The objective of NSESPAN is to identify overall risk in a portfolio of all futures and options contracts for each member. The system treats futures and options contracts uniformly, while at the same time recognizing the unique exposures associated with options portfolios, like extremely deep outofthemoney short positions and intermonth risk. Its overriding objective is to determine the largest loss that a portfolio might reasonably be expected to suffer from one day to the next day based on 99% VaR methodology. SPAN considers uniqueness of option portfolios. The following factors affect the value of an option:
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Underlying market price Strike price Volatility(variability) of underlying instrument Time to expiration Interest rate
As these factors change, the value of options maintained within a portfolio also changes. Thus, SPAN constructs scenarios of probable changes in underlying prices and volatilities in order to identify the largest loss a portfolio might suffer from one day to the next. It then sets the margin requirement to cover this oneday loss. The complex calculations (e.g. the pricing of options) in SPAN are executed by NSCCL. The results of these calculations are called risk arrays. Risk arrays, and other necessary data inputs for margin calculation are provided to members daily in a file called the SPAN risk parameter file. Members can apply the data contained in the risk parameter files, to their specific portfolios of futures and options contracts, to determine their SPAN margin requirements. Hence, members need not execute complex option pricing calculations, which is performed by NSCCL. SPAN has the ability to estimate risk for combined futures and options portfolios, and also revalue the same under various scenarios of changing market conditions.
CALCULATION OF BROKERAGE. Brokerage is the amount paid to the stock broker for the services rendered by him to the client. As per the SEBI guidelines, ASCI can charge maximum 2 percent as brokerage to the clients. Again brokerage differs from branch to branch. Along with brokerage, Service tax at 10 percent, Cess etc., are also added to the amount charged to the client. The brokerage is calculated at the rate of 0.5% or 0.50 paisa, whichever is higher. In NSE &BSE, on Delivery base the brokerage is charged at the rate of 0.5%. For the clients who are trading not frequently, the rate of brokerage is 0.75%. Brokerage is calculated as follows:
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=certain percentage of brokerage* price of a scrip The answer will be multiplied with number of shares traded. For example, If the rate of brokerage is 0.5% The price of a scrip is Ts. 250 And the number of shares traded of that particular scrip is 100 Therefore, amount to be paid as brokerage is, =0.5*250/100 =Rs. 1.25*100 =Rs.125
HIDDEN COST Apart from brokerage other costs like Service charges, Cess, Courier charges, Tax etc., are included in the brokerage, which is called as Hidden cost. Hidden cost adds to the amount of brokerage. Apart from brokerage Service Tax is charged at the rate of 12 percent, Cess is 0.2 percent and Security Transaction Tax is charged at the rate of 0.13 percent (STT). STT is charged on turnover.
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KEY COMBINATIONS USED FOR THE TRANSACTIONS: Buying -F1 or + Selling - F2 or Outstanding or pending position -F3 Delete -F4 Cancellation -F3 Market depth -F6 (no. of buyers, sellers, quantity sold, traded volume etc) Total net position -F8 (transactions traded) Market snapshot -F10 (companys details open, high, low, previous, close etc) Choose instruments -Ctrl +Z Total trading information _Ctrl +N
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FINDINGS
1. During the analysis I found that after opening an account, the transactions, which are made by the investors, are not updated or entered to the concerned investors account and because of this, sometimes the investor has to face some difficulties in accessing his account. 2. NSE follows the NEAT system and BSE follows the BOLT system for trading in the securities. Both of these are Screen Based Trading Systems. 3. The ASCI having broker and sub broker. These two are faciliting the clients to purchase and sell the securities in the secondary market, for that they charge some commission called brokerage. 4. The ASCI Stock Broking Ltd has to fulfill the conditions framed by the SEBI.
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5. Market is being divided into two parts i.e. primary market and secondary market. Primary Market helps to raise fund through IPOs and Secondary Market helps the investor to buy the share from the stock market. SEBI is regulating both the Markets. 6. T+2 rolling settlements have been introduced in the year Aug 2003. 7. NSDL and CSDL, these two are the Depositories in India. 8. Doing the work of online buying and selling of securities on behalf of the client. 9. Trading in Derivatives products like Futures and Options. 10. Helping the client for clearing and settlements.
CONCLUSION 1. Investors can use derivatives instruments in all trends of markets especially options where loss is restricted to the premium paid and profit is unlimited. 2. Introduction of derivatives in Indian market has really served its purpose of reducing the volatility in the spot market. It has made the stock market relatively safer. 3. ASCI is one of the leading brokers at Hubli and it is providing good research reports and investment advices to keep its customers profitable. 4. ASCI is providing many services to the investors along with share broking. Such as demat and Remat services, Mutual Funds, Investments, Personal Tax Planning and Insurance advisory. And it has proved it self as a leading stock broker.
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Suggestions:
1. The awareness about derivatives among investors should be increased by conducting various awareness and educational programs. 2. The company can conduct seminars to promote their services. 3. The company can think of tapping the existing demat account holders and provide them enough information on derivatives and enable them to trade in the same. This will help the company to increase its earnings of brokerage income. 4. The company has to create and maintain a database of prospective customers from time to time, to keep track of the people falling in different income levels and their investing patterns. This is possible if continuous contacts are maintained with the customers.
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5. The problems faced by the customers in online trading like placing of orders, delivery, margins etc. have to be attended quickly so that they carry an outstanding and reliable image outside.
BIBLIOGRAPHY WWW. APPOLLO SINDHOORI.COM WWW.GOOLGE.COM WWW.ICICIDIRECT.COM WWW.NSEINDIA.COM The data was collected from the list of Books and websites given below: Options, Futures and Other Derivatives John C Hull
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Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Objective of the analysis

Need for the study

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Services and qualities of ASCI Ltd

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

C). Publications The Finapolis ASCI Bazaar Baatein.

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Indian derivatives markets 1. Rise of Derivatives

2. Definition and Uses of Derivatives

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Why do institutions not participate to a greater extent in derivatives markets?

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Why have derivatives?

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Example: Futures contracts in Nifty in July 2001

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Cost (Rs) 1000

Selling price 4000

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Less: Purchase Cost: 3600*100 = Rs.3,60,000 Net gain Rs.40,000

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

If there is a difference then arbitrage opportunity exists.

Cost= 1000+30 = 1030 Arbitrage profit = 40

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori

Cost= 1000+30 = 1030 Arbitrage profit 40

BABASAB PATIL PROJECT REPORT ON FINANCE

Analysis of Derivatives and Stock Broking at Apollo Sindhoori