CHAPTER-1

INTRODUCTION

1
INTRODUCTION:

The only stock exchange operating in the 19th century were those of Bombay set up in

1875 and Ahmadabad set up in 1894. These were organized as voluntary non-profit-making

association of brokers to regulate and protect their interests. Before the control on securities

trading became a central subject under the constitution in 1950, it was a state subject and the

Bombay securities contracts (control) Act of 1925 used to regulate trading in securities. Under

this Act, The Bombay stock exchange was recognized in 1927 and Ahmadabad in 1937.

During the war boom, a number of stock exchanges were organized even in Bombay,

Ahmadabad and other centers, but they were not recognized. Soon after it became a central

subject, central legislation was proposed and a committee headed by A.D.Gorwala went into the

bill for securities regulation. On the basis of the committee's recommendations and public

discussion, the securities contracts (regulation) Act became law in 1956.

2
OBJECTIVES OF STUDY:

1. To study various trends in derivative market.

2. Comparison of the profits/losses in cash market and derivative market.

3. To find out profit/losses position of the option writer and option holder.

4. To study in detail the role of the future and options.

5. To study the role of derivatives in Indian financial market.

6. To study various trends in derivative market.

7. Comparison of the profits/losses in cash market and derivative market.

8. To find out profit/losses position of the option writer and option holder.

9. To study in detail the role of the future and options.

10. To study the role of derivatives in Indian financial market.

3
NEED OF THE STUDY

• Different investment avenues are available investors. Stock market also offers good

investment opportunities to the investor alike all investments, they also carry certain

risks. The investor should compare the risk and expected yields after adjustment off

tax on various instruments while talking investment decision the investor may seek

advice from exparty and consultancy include stock brokers and analysts while making

investment decisions. The objective here is to make the investor aware of the

functioning of the derivatives.

• Derivatives act as a risk hedging tool for the investors. The objective if to help the

investor in selecting the appropriate derivates instrument to the attain maximum risk

and to construct the portfolio in such a manner to meet the investor should decide

how best to reach the goals from the securities available.

• To identity investor objective constraints and performance, which help formulate the

investment policy?

• The develop and improvement strategies in the with investment policy formulated.

They will help the selection of asset classes and securities in each class depending up

on their risk return attributes.

4
SCOPE OF THE STUDY

The study is limited to “Derivatives” with special reference to futures and options in the

Indian context; the study is not based on the international perspective of derivative markets.

The study is limited to the analysis made for types of instruments of derivates each

strategy is analyzed according to its risk and return characteristics and derivatives performance

against the profit and policies of the company.

The present study on futures and options is very much appreciable on the grounds that it

gives deep insights about the F&O market. It would be essential for the perfect way of trading in

F&O. An investor can choose the fight underlying or portfolio for investment 3which is risk free.

The study would explain the various ways to minimize the losses and maximize the profits. The

study would help the investors how their profit/loss is reckoned. The study would assist in

understanding the F&O segments. The study assists in knowing the different factors that cause

for the fluctuations in the F&O market. The study provides information related to the byelaws of

F&O trading. The studies elucidate the role of F&O in India Financial Markets.

Derivative Markets today

• The prohibition on options in SCRA was removed in 1995. Foreign currency options in

currency pairs other than Rupee were the first options permitted by RBI.

• The Reserve Bank of India has permitted options, interest rate swaps, currency swaps and

other risk reductions OTC derivative products.

5
• Besides the Forward market in currencies has been a vibrant market in India for several

decades.

• In addition the Forward Markets Commission has allowed the setting up of commodities

futures exchanges. Today we have 18 commodities exchanges most of which trade

futures.

e.g. The Indian Pepper and Spice Traders Association (IPSTA) and the Coffee Owners

Futures Exchange of India (COFEI).

• In 2000 an amendment to the SCRA expanded the definition of securities to included

Derivatives thereby enabling stock exchanges to trade derivative products.

• The year 2000 will herald the introduction of exchange traded equity derivatives in India

for the first time.

6
METHODOLOGY

To achieve the object of studying the stock market data ha been collected.

Research methodology carried for this study can be two types

 Primary

 Secondary

PRIMARY

The data, which is being collected for the time and it is the original data is this

project the primary data has been taken from IIFL staff and guide of the project.

SECONDARY

The secondary information is mostly from websites, books, journals, etc.

7
CHAPTER-2
INDUSTRY PROFILE

8
 INDUSTRY PROFILE :

STOCK MARKET :

Indian stock market has shown dramatic changes last 4 to 5 years. As of 2004 march-

end, Indian stock exchanges had over 9400 companies listed. Of course, the number of

companies whose shares are actively traded is smaller, around 800 at the NSE and 2600 at the

BSE. Each company may have multiple securities listed on an exchange. Thus, BSE has over

7200 listed securities, of which over 2600 are traded. The market capitalization of all listed

stocks now exceeds Rs. 13 Lakh crore. Total turnover-or the value of all sales and purchases –

on the BSE and the NSE now exceeds Rs. 50 lakh crore.

As large number of indices are also available to fund managers. The two leading

market indices are NSE 50-shares (S&P CNX Nifty) index and BSE 30-share (SENSEX) index.

There are index funds that invest in the securities that form part of one or the other index.

Besides, in the derivatives market, the fund managers can buy or sell futures contracts or options

contracts on these indices. Both BSE and NSE also have other sect oral indices that track the

stocks of companies in specific industry groups-FMCG, IT, Finance, Petrochemical and

Pharmaceutical while the SENSEX and Nifty indices track large capitalization stocks, BSE and

NSE also have Mid cap indices tracking mid-size company shares. The number of industries or

sectors represented in various indices or in the listed category exceeds50. BSE has 140 scrips in

its specified group A list, which are basically large-capitalization stocks. B 1 Group includes

9
over 1100 stocks, many of which are mid-cap companies. The rest of the B2 Group includes over

4500 shares, largely low-capitalization.

National Stock Exchange (NSE):

The NSE was incorporated in NOVEMBER 1994 with an equity capital of Rs.25
Crores. The International Securities Consultancy (ISC) of Hong Kong has helped in setting up
NSE. The promotions for NSE were financial institutions, insurance companies, banks and SEBI
capital market ltd,Infrastructure leasing and financial services ltd.,stock holding corporation ltd.
NSE is a national market for shares, PSU bonds, debentures and government
securities since infrastructure and trading facilities are provided. The genesis of the NSE lies in
the recommendations of the Pherwani Committee (1991).

NSE-Nifty:

The NSE on April22, 1996 launched a new equity index. The NSE-50 the new index
which replaces the existing NSE-100, is expected to serve as an appropriate index for the new
segment of futures and options.
“Nifty” means National Index for Fifty Stocks.
The NSE-50 comprises 50 companies that represent 20 broad industry groups with
an aggregate market capitalization of around Rs. 1,70,000 crores. All the companies included in
the Index have a market capitalization in excess of Rs. 500 crores. Each and should have traded
for 85% of trading days at an impact cost of less than 1.5%.

NSE-Midcap Index:

The NSE midcap index or the Junior Nifty comprises 50 stocks that represents 21
board Industry groups and will provide proper representation of the midcap. All stocks in the
index should have market capitalization of greater than Rs.200 crores and should have traded
85% of the trading days an impact cost of less 2.5%.

10
 The base period for the index is Nov 4, 1996 which signifies 2 years for completion
of operations of the capital market segment of the operations. The base value of the index has
been set at 1000. Average daily turnover of the present scenario 258212(laces) and number of
average daily trades 2160(laces).

Bombay Stock Exchange (BSE):

This stock exchange, Mumbai, popularly known as “BSE” was established In 1875 as
“The native share and stock brokers association”, as a voluntary non-profit making association .It
has evolved over the years into its present status as the premier stock exchange in the country. It
may be noted that the stock exchange is the oldest one in Asia, even older than the Tokyo Stock
Exchange, this was founded in 1878.

The Bombay Stock Exchange Limited is the oldest stock exchange in Asia and has the
greatest number of listed companies in the world, with 4700 listed as of August 2007.It is located
at Dalal Street, Mumbai, India. On 31 December 2007, the equity market capitalization of the
companies listed on the BSE was US$ 1.79 trillion, making it the largest stock exchange in South
Asia and the 12th largest in the world.

A governing board comprising of 9 elected directors, 2 SEBI nominees, 7 public

representatives and an executive director is the apex body, which decides the policies and
regulates the affairs of the exchange.

BSE Indices:

In order to enable the market participants, analysts etc., to track the various ups and
downs in Indian stock market, the exchange had introduced in 1986 an equity stock index called
BSE-SENSEX that subsequently became the barometer of the moments of the share prices in the
Indian stock market. It is a “market capitalization –weighted” index of 30 component stocks
representing a sample of large, well established and leading companies. The base year of sensex
is 1978-79.
The Sensex is widely reported in both domestic and international markets through
print as well as electronic media. Sensex is calculated using a market capitalization weighted

11
method. As per this methodology, the level of index reflects the total market value of all 30-
component stocks from different industries related to particular base period. The total value of a
company is determined by multiplying the price of its stock by the number of shares outstanding.

Statisticians call an index of a set of combined variables (such as price number of

shares) Composite index. An Indexed number is used to represent the results of this calculation
in order to make the value easier to work with and track over a time. IT is much easier to graph a
chart base on indexed values then one based on actual values world over majority of the well
known indices are constructed using “Market capitalization weighted method”. The divisor is
only link to original base period value of the sensex.

New base year average = old base year average*(new market value/old market value)

OTC Equity Derivatives

• Traditionally equity derivatives have a long history in India in the OTC market.
• Options of various kinds (called Teji and Mandi and Fatak) in un-organized markets were
traded as early as 1900 in Mumbai
• The SCRA however banned all kind of options in 1956.

BSE's and NSE’s plans

• Both the exchanges have set-up an in-house segment instead of setting up a separate
exchange for derivatives.
• BSE’s Derivatives Segment, will start with Sensex futures as it’s first product.
• NSE’s Futures & Options Segment will be launched with Nifty futures as the first
product.

Product Specifications BSE-30 Sensex Futures

• Contract Size - Rs.50 times the Index
• Tick Size - 0.1 points or Rs.5
• Expiry day - last Thursday of the month

12
 • Settlement basis - cash settled
• Contract cycle - 3 months
• Active contracts - 3 nearest months

Product Specifications S&P CNX Nifty Futures

• Contract Size - Rs.200 times the Index
• Tick Size - 0.05 points or Rs.10
• Expiry day - last Thursday of the month
• Settlement basis - cash settled
• Contract cycle - 3 months
• Active contracts - 3 nearest months
Membership
• Membership for the new segment in both the exchanges is not automatic and has to be
separately applied for.
• Membership is currently open on both the exchanges.
• All members will also have to be separately registered with SEBI before they can be
accepted.
Membership Criteria
NSE
Clearing Member (CM)
• Networth - 300 lakh
• Interest-Free Security Deposits - Rs. 25 lakh
• Collateral Security Deposit - Rs. 25 lakh
In addition for every TM he wishes to clear for the CM has to deposit Rs. 10 lakh.
Trading Member (TM)
• Networth - Rs. 100 lakh
• Interest-Free Security Deposit - Rs. 8 lakh
• Annual Subscription Fees - Rs. 1 lakh
BSE
Clearing Member (CM)
• Networth - 300 lacs

13
 • Interest-Free Security Deposits - Rs. 25 lakh
• Collateral Security Deposit - Rs. 25 lakh
• Non-refundable Deposit - Rs. 5 lakh
• Annual Subscription Fees - Rs. 50 thousand
In addition for every TM he wishes to clear for the CM has to deposit Rs. 10 lakh with the
following break-up.
• Cash - Rs. 2.5 lakh
• Cash Equivalents - Rs. 25 lakh
• Collateral Security Deposit - Rs. 5 lakh
Trading Member (TM)
• Networth - Rs. 50 lakh
• Non-refundable Deposit - Rs. 3 lakh
• Annual Subscription Fees - Rs. 25 thousand
The Non-refundable fees paid by the members is exclusive and will be a total of Rs.8 lakhs if the
member has both Clearing and Trading rights.
Trading Systems
• NSE’s Trading system for it’s futures and options segment is called NEAT F&O. It is
based on the NEAT system for the cash segment.
• BSE’s trading system for its derivatives segment is called DTSS. It is built on a platform
different from the BOLT system though most of the features are common.
Certification Programmes
• The NSE certification programme is called NCFM (NSE’s Certification in Financial
Markets). NSE has outsourced training for this to various institutes around the country.
• The BSE certification programme is called BCDE (BSE’s Certification for the
Derivatives Exchnage). BSE conducts it’s own training run by it’s training institute.
• Both these programmes are approved by SEBI.
Rules and Laws
• Both the BSE and the NSE have been give in-principle approval on their rule and laws by
SEBI.
• According to the SEBI chairman, the Gazette notification of the Bye-Laws after the final
approval is expected to be completed by May 2000.

14
• Trading is expected to start by mid-June 2000.

CHAPTER-3
COMPANY PROFILE

15
 COMPANY PROFILE:

THE INDIA INFOLINE LIMITED

Origin:
India infoline Ltd., was founded in 1995 by a group of professional with impeccable
educational qualifications and professional credentials. Its institutional investors include Intel
Capital (world's) leading technology company, CDC (promoted by UK government), ICICI,
TDA and Reeshanar.
India Infoline group offers the entire gamut of investment products including stock
broking, Commodities broking, Mutual Funds, Fixed Deposits, GOI Relief bonds, Post office
savings and life Insurance. India Infoline is the leading corporate agent of ICICI Prudential Life
Insurance Co. Ltd., which is India' No. 1 Private sector life insurance company.
www.indiainfoline.com has been the only India Website to have been listed by none other than
Forbes in it's 'Best of the Web' survey of global website, not just once but three times in a row
and counting... “A must read for investors in south Asia” is how they choose to describe India
Infoline. It has been rated as No.l the category of Business News in Asia by Alexia rating.
Stock and Commodities broking is offered under the trade name 5paisa. India Infoline
Commodities pvt Ltd., a wholly owned subsidiary of India Infoline Ltd., holds membership of
MCX and NCDEX

16
Main Objects of the Company
Main objects as contained in its Memorandum or Association are:
1. To engage or undertake software and internet based services, data processing IT enabled
services, software development services, selling advertisement space on the site, web consulting
and related services including web designing and web maintenance, software product
development and marketing, software supply services, computer consultancy services, E-
Commerce of all types including electronic financial intermediation business and E-broking,
market research, business and management consultancy.
2. To undertake, conduct, study, carry on, help, promote any kind of research, probe,
investigation, survey, developmental work on economy, industries, corporate business houses,
agricultural and mineral, financial institutions, foreign financial institutions, capital market on
matters related to investment decisions primary equity market, secondary equity market,
debentures, bond, ventures, capital funding proposals, competitive analysis, preparations of
corporate / industry profile etc. and trade / invest in researched securities
VISION STATEMENT OF THE COMPANY:
“Our vision is to be the most respected company in the financial services space In India”.

Products: the India Infoline pvt ltd offers the following products
A.E-broking.
B. Distribution
C.Insurance
D. PMS
E. Mortgages
A. E-Broking:
It refers to Electronic Broking of Equities, Derivatives and Commodities under the brand name
of 5paisa
1. Equities
2. Derivatives
3. Commodities
B.Distribution:
1. Mutual funds
17
2. Govt of India bonds.
3. Fixed deposits
C.Insurance:
1. Life insurance policies
2. General Insurance.
3. Health Insurance Policies.

THE CORPORATE STRUCTURE

The India Infoline group comprises the holding company, India Infoline Ltd, which has 5
wholly-owned subsidiaries, engaged in distinct yet complementary businesses which together
offer a whole bouquet of products and services to make your money grow.
The corporate structure has evolved to comply with oddities of the regulatory framework but still
beautifully help attain synergy and allow flexibility to adapt to dynamics of different businesses.
The parent company, India Infoline Ltd owns and managers the web properties
www.Indiainfoline.com and www.5paisa.com. It also undertakes research Customized and off-
the-shelf.
Indian Infoline Securities Pvt. Ltd. is a member of BSE, NSE and DP with NSDL. Its business
encompasses securities broking Portfolio Management services.
India Infoline.com Distribution Co. Ltd., Mobilizes Mutual Funds and other personal investment
products such as bonds, fixed deposits, etc.
India Infoline Insurance Services Ltd. Is the corporate agent of ICICI Prudential Life Insurance,
engaged in selling Life Insurance, General Insurance and Health Insurance products.
India Infoline Commodities Pvt. Ltd. is a registered commodities broker MCX and offers futures
trading in commodities.
India Infoline Investment Services Pvt Ltd., is proving margin funding and NBFC services to the
customers of India Infoline Ltd.,

18
Pictorial Representation of India Infoline Ltd

Management of India Infoline Ltd.,

India Infoline is a professionally managed Company. The promoters who run the company/s

day-to-day affairs as executive directors have impeccable academic professional track records.

Nirmal Jain, chairman and Managing Director, is a Chartered Accountant, (All India Rank 2);

Cost Account, (All India Rank l) and has a post-graduate management degree from IIM

Ahmedabad. He had a successful career with Hindustan Lever, where he inter alia handled

Commodities trading and export business. Later he was CEO of an equity research organization.

19
R. Venkataraman, Director, is armed with a post- graduate management degree from IIM

Bangalore, and an Electronics Engineering degree from IIT, Kharagpur. He spent eight fruitful

years in equity research sales and private equity with the cream of financial houses such as ICICI

group, Barclays de Zoette and G.E. Capital

The non-executive directors on the board bring a wealth of experience and expertise.

Satpal khattar -Reeshanar investments, SingaporeThe key management team comprises seasoned

and qualified professionals.

Mukesh Sing- Director, India Infoline Securities Pvt Ltd.

Seshadri Bharathan- Director, India Infoline. Com Distribution Co Ltd
S Sriram- Vice President, Technology
Sandeepa Vig Arora- Vice President, Portfolio Management Services
Dharmesh Pandya- Vice President, Alternate Channel
Toral Munshi- Vice President, Research
Anil Mascarenhas- Chief Editor
Pinkesh Soni Financial controller
Harshad Apte Chief Marketing Officer

Human Resources :

I. General:

Management is committed to provide necessary resources which are required as identified in

documents like Quality system procedures, work instructions and quality forms / other
documents etc.
Personnel assigned to various tasks are suitably qualified with formal job training, education, and
/ or experience.

II . Competence, awareness and training:

• The necessary competence are determines for personnel performing work affecting
product quality
• Identified and provides necessary training as and when required to the employees to meet
the customer needs.

20
• Evaluates the effective of training.
• Ensures that employees are aware of the relevance and importance of their activities and
how they contribute to the achievement of the quality objectives.
• Maintains appropriate records of education, training, skills and experience

Work Environment:

It is determined and managed the work environment need to achieve conformity to product
requirements.

MISSION, VISION, CORE VALUES

Mission:

To maintain the customer satisfaction level, with zero defect supply.

Vision:

To become one of the best forging company in south India with press technology

Core values:

• Quality
• Service at any cost
• Cordial relation ship
• Collective team work

Organization of Employees in INDIA INFOLINE LTD along with

Minimum Competence level

The Manpower is categorized as Non-technical & Technical. In the non-technical category four
identified levels are present. They are Manger, Asst. Manager, officer & Assistant. Minimum
competence details are given in the chart
In the technical category C.E.O. is Chief lead a technical and a business qualification. In the top-
management category G. Manager, Dy. Gen. Manager, and Asst. Gen. Manager levels are there,
these report to C.E.O. In the middle management category the levels are Manager, Asst.
Manager, Sales manager , team manager, relationship managers, dealers are in the Junior
Management category.
The work force of consists of operators (experienced and skilled), apprentice, and helper. The
details are given in organization chart.

21
CHAPTER-4
REVIEW LITERATURE

22
REASON TO CHOOSE INDIA INFOLINE LTD
Experience
INDIA INFOLINE LTD has more than eight decades of trust and credibility in the Indian
stock market. In the Asia Money broker's poll held recently, INDIA INFOLINE LTD won the
'India's best broking house for 2004' award. Ever since it launched INDIA INFOLINE LTD as its
retail broking division in February 2000, it has been providing institutional-level research and
broking services to individual investors.
Technology
With their online trading account one can buy and sell shares in an instant from any PC
with an internet connection. Customers get access to the powerful online trading tools that will
help them to take complete control over their investment in shares.
Knowledge
In a business where the right information at the right time can translate into direct profits,
investors get access to a wide range of information on the content-rich portal,
www. India infoline .com Investors will also get a useful set of knowledge-based tools that will
empower them to take informed decisions.
Convenience
One can call India infoline Dial-N-Trade number to get investment advice and execute
his/her transactions. They have a dedicated call-center to provide this service via a Toll Free
Number 1800 22-7500 & 39707500 from anywhere in India.
Customer Service
Its customer service team assist their customer for any help that they need relating to
transactions, billing, demat and other queries. Their customer service can be contacted via a toll
free number, email or live chat on www. India infoline.com.
Investment Advice
India infoline has dedicated research teams of more than 30 people for fundamental and
technical research. Their analysts constantly track the pulse of the market and provide timely

23
investment advice to customer in the form of daily research emails, online chat, printed reports
etc.

Benefits
 Free Depository A/c
 Instant Cash Transfer
 Multiple Bank Option.
 Secure Order by Voice Tool Dial-n-Trade.
 Automated Portfolio to keep track of the value of your actual purchases.
 Personalized Price and Account Alerts delivered instantly to your Mobile Phone &
Email address.
 Special Personal Inbox for order and trade confirmations.
 On-line Customer Service via Web Chat.
 Buy or sell even single share
 Anytime Ordering.

INDIA INFOLINE offers the following products :-

Classic account
This is a User Friendly Product which allows the client to trade through website
www. India infoline.com and is suitable for the retail investors who is risk-averse and hence
prefers to invest in stocks or who does not trade too frequently.
Features
♦ Online trading account for investing in Equity and Derivatives via
www. India infoline.com
♦ Live Terminal and Single terminal for NSE Cash, NSE F&O & BSE.
♦ Integration of On-line trading, Saving Bank and Demat Account.
♦ Instant cash transfer facility against purchase & sale of shares.

24
 ♦ Instant order and trade confirmation by E-mail.
♦ Streaming Quotes (Cash & Derivatives).

Speed trade:
SPEEDTRADE is an internet-based software application that enables you to buy and
sell in an instant. It is ideal for active traders and jobbers who transact frequently during day’s
session to capitalize on intra-day price movement.
Features
♦ Single screen trading terminal for NSE Cash, NSE F&O & BSE.
♦ Technical Studies & Multiple Charting.
♦ Market summary (Cost traded scrip, highest clue etc.)
♦ Alerts and reminders.
♦ Back-up facility to place trades on Direct Phone lines.
Dial-n-trade:
Along with enabling access for trade online, the CLASSIC and SPEEDTRADE
ACCOUNT also gives Dial-n-trade services. With this service, one can dial India infoline
dedicated phone lines 1800-22-7500, 3970-7500. Beside this, Relationship Managers are always
available on Office Phone and Mobile to resolve customer queries.

India infoline mobile:

India infoline had introduced India infoline Mobile, mobile based software where one can
watch Stock Prices, Intra Day Charts, Research & Advice and Trading Calls live on the Mobile.
(As per SEBI regulations, buying-selling shares through a mobile phone are not yet permitted.)
Prepaid account:
Customers pay Advance Brokerage on trading Account and enjoy uninterrupted trading
in their Account. Beside this, great discount are also available (up to 50%) on brokerage.
 Prepaid Classic Account: - Rs. 2000

25
  Prepaid Speed trade Account: - Rs. 6000
Ipo on-line:
Customers can apply to all the forthcoming IPOs online. This is quite hassle-free,
paperless and time saving. Simply allocate fund to IPO Account, Apply for the IPO and Sit Back
& Relax.

Mutual fund online:

Investors can apply to Mutual Funds of Reliance, Franklin Templeton Investments, ICICI
Prudential, SBI, Birla, Sundaram, HDFC, DSP Merrill Lynch, PRINCIPAL and TATA with
Share khan.

Zero balance icici saving account:

India infoline had tied-up with ICICI bank for Zero Balance Account for India infoline
Clients. Now their customers can have a Zero Balance Saving Account with ICICI Bank after
your demat account creation with India infoline.

AWARDS:
1. Rated among the top 20 wired companies along with Reliance, HLL, Infosys etc by
Business Today Jan 2004 edition.
2. PIONEERS of online trading in India.
3. Amongst the top 3 online trading websites from India.
4. Most preferred financial destination amongst online banking customers.
5. Winner of ‘Best Financial Website Award
6. Awarded to India infoline at the Awaaz ‘Consumer Awards 2005’ in the "Stock
Broking" category.

26
 Introduction

A Derivative is a financial instrument that derives its value from an underlying

asset. Derivative is an financial contract whose price/value is dependent upon price of one or
more basic underlying asset, these contracts are legally binding agreements made on trading
screens of stock exchanges to buy or sell an asset in the future. The most commonly used
derivatives contracts are forwards, futures and options, which we shall discuss in detail later.
The emergence of the market for derivative products, most notably forwards, futures
and options, can be traced back to the willingness of risk-averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices. By their very nature,
the financial markets are marked by a very high degree of volatility. Through the use of
derivative products, it is possible to partially or fully transfer price risks by locking-in asset
prices. As instruments of risk management, these generally do not influence the fluctuations in
the underlying asset prices. However, by locking-in asset prices, derivative products minimize
the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-
averse investors.
Derivative products initially emerged, as hedging devices against fluctuations in
commodity prices and commodity-linked derivatives remained the sole form of such products for
almost three hundred years. The financial derivatives came into spotlight in post-1970 period due
to growing instability in the financial markets. However, since their emergence, these products
have become very popular and by 1990s, they accounted for about two-thirds of total
transactions in derivative products. In recent years, the market for financial derivatives has
grown tremendously both in terms of variety of instruments available, their complexity and also
turnover. In the class of equity derivatives, futures and options on stock indices have gained
more popularity than on individual stocks, especially among institutional investors, who are

27
major users of index-linked derivatives. Even small investors find these useful due to high
correlation of the popular indices with various portfolios and ease of use. The lower costs
associated with index derivatives vie derivative products based on individual securities is another
reason for their growing use.
The main objective of the study is to analyze the derivatives market in India and to
analyze the operations of futures and options. Analysis is to evaluate the profit/loss position
futures and options. Derivates market is an innovation to cash market. Approximately its daily
turnover reaches to the equal stage of cash market

In cash market the profit/loss of the investor depend the market price of the underlying
asset. Derivatives are mostly used for hedging purpose. In bullish market the call option writer
incurs more losses so the investor is suggested to go for a call option to hold, where as the put
option holder suffers in a bullish market, so he is suggested to write a put option. In bearish
market the call option holder will incur more losses so the investor is suggested to go for a call
option to write, where as the put option writer will get more losses, so he is suggested to hold a
put option.
Initially derivatives was launched in America called Chicago. Then in 1999, RBI
introduced derivatives in the local currency Interest Rate markets, which have not really
developed, but with the gradual acceptance of the ALM guidelines by banks, there should be an
instrumental product in hedging their balance sheet liabilities.
The first product which was launched by BSE and NSE in the derivatives market was
index futures
The following factors have been driving the growth of financial derivatives:
1. Increased volatility in asset prices in financial markets,
2. Increased integration of national financial markets with the international markets,
3. Marked improvement in communication facilities and sharp decline in their costs,
4. Development of more sophisticated risk management tools, providing economic
agents a wider choice of risk management strategies, and
5. Innovations in the derivatives markets, which optimally combine the risks and
returns over a large number of financial assets, leading to higher returns, reduced
risk as well as trans-actions costs as compared to individual financial assets.

28
Derivatives defined
Derivative is a product whose value is derived from the value of one or more basic
variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The
underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers
may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that
date. Such a transaction is an example of a derivative.
The price of this derivative is driven by the spot price of wheat which is the “underlying”.
In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines
“equity derivative” to include –
1. A security derived from a debt instrument, share, loan whether secured or
unsecured, risk instrument or contract for differences or any other form of security.
2. A contract, which derives its value from the prices, or index of prices, of
underlying securities.

Derivatives is derived from the following products:

A. Shares
B. Debuntures
C. Mutual funds
D. Gold
E. Steel
F. Interest rate
G. Currencies.

DEFINATIONS

29
 According to JOHN C. HUL “ A derivatives can be defined as a financial instrument
whose value depends on (or derives from) the values of other, more basic underlying variables.”
According to ROBERT L. MCDONALD “A derivative is simply a financial instrument
(or even more simply an agreement between two people) which has a value determined by the
price of something else.

FUNCTIONS OF DERIVATIVES MARKET:

The following are the various functions that are performed by the derivatives markets.
They are:

 Prices in an organized derivatives market reflect the perception of market participants about
the future and lead the prices of underlying to the perceived future level.
 Derivatives market helps to transfer risks from those who have them but may not like them to
those who have an appetite for them.
 Derivative trading acts as a catalyst for new entrepreneurial activity.
 Derivatives markets help increase savings and investment in the long run.

TYPES OF DERIVATIVES:

The most commonly used derivatives contracts are forwards, futures and options
which we shall discuss in detail later. Here we take a brief look at various derivatives
contracts that have come to be used.

Forwards:
A forward contract is a customized contract between two entities, where settlement
takes place on a specific date in the future at today’s pre-agreed price

Futures:

30
 A futures contract is an agreement between two parties to buy or sell an asset at a
certain time in the future at a certain price. Futures contracts are special types of forward
contracts in the sense that the former are standardized exchange-traded contracts
Options:
Options are of two types - calls and puts. Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset, at a given price on or before a given
future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the
underlying asset at a given price on or before a given date.
Warrants:
Options generally have lives of up to one year; the majority of options traded on
options exchanges having a maximum maturity of nine months. Longer-dated options are
called warrants and are generally traded over-the-counter.

Leaps:
The acronym LEAPS means Long-Term Equity Anticipation Securities. These are
options having a maturity of up to three years.
Baskets:
Basket options are options on portfolios of underlying assets. The underlying asset is
usually a moving average of a basket of assets. Equity index options are a form of basket
options.
Swaps:
Swaps are private agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts. The
two commonly used swaps are
⇒ Interest rate swaps:
These entail swapping only the interest related cash flows between the
Parties in the same currency.
⇒ Currency swaps:
These entail swapping both principal and interest between the parties, with the
cash flows in one direction being in a different currency than those in the opposite Direction.
Swaptions:
31
 Swaptions are options to buy or sell a swap that will become operative at the expiry of
the options. Thus a Swaptions is an option on a forward swap.

PARTICIPANTS IN THE DERIVATIVES MARKET:

The following three broad categories of participants in the derivatives market.

HEDGERS:
Hedgers face risk associated with the price of an asset. They use futures or options
markets to reduce or eliminate this risk.

SPECULATORS:
Speculators wish to bet on future movements in the price of an asset. Futures and options
contracts can give them an extra leverage; that is, they can increase both the potential gains and
potential losses in a speculative venture.

ARBITRAGEURS:
Arbitrageurs are in business to take advantage of a discrepancy between prices in two
different markets. If, for example, they see the futures price of an asset getting out of line with
the cash price, they will take offsetting positions in the two markets to lock in a profit.

ANY EXCHANGE FULFILLING THE DERIVATIVE SEGMENT AT NATIONAL

STOCK EXCHANGE:

32
 The derivatives segment on the exchange commenced with S&P CNX Nifty Index
futures on June 12, 2000. The F&O segment of NSE provides trading facilities for the following
derivative segment:
1. Index Based Futures
2. Index Based Options
3. Individual Stock Options
4. Individual Stock Futures

REGULATORY FRAMEWORK:

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

Regulation for Derivative Trading:

SEBI set up a 24 member committed under Chairmanship of Dr.L.C.Gupta develop the

appropriate regulatory framework for derivative trading in India. The committee submitted its
report in March 1998. On May 11, 1998 SEBI accepted the recommendations of the committee
and approved the phased introduction of Derivatives trading in India beginning with Stock Index
Futures. SEBI also approved he “Suggestive bye-laws” recommended by the committee for
regulation and control of trading and settlement of Derivatives contracts.
The provisions in the SC (R) A govern the trading in the securities. The
amendment of the SC (R) A to include “DERIVATIVES” within the ambit of ‘Securities’ in the
SC (R ) A made trading in Derivatives possible within the framework of the Act.

1. Eligibility criteria as prescribed in the L.C. Gupta committee report may apply to SEBI
for grant of recognition under Section 4 of the SC ( R ) A, 1956 to start Derivatives
Trading. The derivatives exchange/segment should have a separate governing council

33
 and representation of trading / clearing members shall be limited to maximum of 40% of
the total members of the governing council. The exchange shall regulate the sales
practices of its members and will obtain approval of SEBI before start of Trading in any
derivative contract.

2. The exchange shall have minimum 50 members.

3. The members of an existing segment of the exchange will not automatically become the
members of the derivative segment. The members of the derivative segment need to
fulfill the eligibility conditions as lay down by the L.C.Gupta Committee.
4. The clearing and settlement of derivates trades shall be through a SEBI
approved Clearing Corporation / Clearing house. Clearing Corporation /
Clearing House complying with the eligibility conditions as lay down
By the committee have to apply to SEBI for grant of approval.

5. Derivatives broker/dealers and Clearing members are required to seek registration from
SEBI.

6. The Minimum contract value shall not be less than Rs.2 Lakh. Exchanges should also
submit details of the futures contract they purpose to introduce.

7. The trading members are required to have qualified approved user and sales person who
have passed a certification programmed approved by SE

INTRODUCTION TO FUTURE MARKET:

Futures markets were designed to solve the problems that exit in forward markets. A
futures contract is an agreement between two parties to buy or sell an asset at a certain time in
the future at a certain price. There is a multilateral contract between the buyer and seller for a

34
underlying asset which may be financial instrument or physical commodities. But unlike forward
contracts the future contracts are standardized and exchange traded.

PURPOSE:
The primary purpose of futures market is to provide an efficient and effective mechanism
for management of inherent risks, without counter-party risk. The future contracts are affected
mainly by the prices of the underlying asset. As it is a future contract the buyer and seller has to
pay the margin to trade in the futures market.
It is essential that both the parties compulsorily discharge their respective obligations on
the settlement day only, even though the payoffs are on a daily marking to market basis to avoid
default risk. Hence, the gains or losses are netted off on a daily basis and each morning starts
with a fresh opening value. Here both the parties face an equal amount of risk and are also
required to pay upfront margins to the exchange irrespective of whether they are buyers or
sellers. Index based financial futures are settled in cash unlike futures on individual stocks which
are very rare and yet to be launched even in the US. Most of the financial futures worldwide are
index based and hence the buyer never comes to know who the seller is, both due to the presence
of the clearing corporation of the stock exchange in between and also due to secrecy reasons

EXAMPLE:

The current market price of INFOSYS COMPANY is Rs.1650.

There are two parties in the contract i.e. Hitesh and Kishore. Hitesh is bullish and kishore is
bearish in the market. The initial margin is 10%. paid by the both parties. Here the Hitesh has
purchased the one month contract of INFOSYS futures with the price of Rs.1650.The lot size of
Infosys is 300 shares.

Suppose the stock rises to 2200.

Unlimited profit for the buyer(Hitesh) = Rs.1,65,000 [(2200-1650*3oo)] and notional profit for
the buyer is 500.
Unlimited loss for the buyer because the buyer is bearish in the market

35
 Suppose the stock falls to Rs.1400
Unlimited profit for the seller = Rs.75,000.[(1650-1400*300)] and notional profit for the seller is
250.
Unlimited loss for the seller because the seller is bullish in the market.
Finally, Futures contracts try to "bet" what the value of an index or commodity will be
at some date in the future. Futures are often used by mutual funds and large institutions to hedge
their positions when the markets are rocky. Also, Futures contracts offer a high degree of
leverage, or the ability to control a sizable amount of an asset for a cash outlay, which is distantly
small in proportion to the total value of contract.

DEFINITION
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. To facilitate liquidity in the futures contract, the exchange
specifies certain standard features of the contract. The standardized items on a futures contract
are:
♦ Quantity of the underlying
♦ Quality of the underlying
♦ The date and the month of delivery
♦ The units of price quotations and minimum price change
♦ Locations of settlement

Types of futures:
On the basis of the underlying asset they derive, the futures are divided into two types:

 Stock futures:
The stock futures are the futures that have the underlying asset as the individual
securities. The settlement of the stock futures is of cash settlement and the settlement price of
the future is the closing price of the underlying security.

 Index futures:

36
 Index futures are the futures, which have the underlying asset as an Index. The Index
futures are also cash settled. The settlement price of the Index futures shall be the closing value
of the underlying index on the expiry date of the contract.

STOCK INDEX FUTURES

Stock Index futures are the most popular financial futures, which have been
used to hedge or manage the systematic risk by the investors of Stock Market. They are called
hedgers who own portfolio of securities and are exposed to the systematic risk. Stock Index is
the apt hedging asset since the rise or fall due to systematic risk is accurately shown in the Stock
Index. Stock index futures contract is an agreement to buy or sell a specified amount of an
underlying stock index traded on a regulated futures exchange for a specified price for settlement
at a specified time future.
Stock index futures will require lower capital adequacy and margin requirements
as compared to margins on carry forward of individual scrips. The brokerage costs on index
futures will be much lower.
Savings in cost is possible through reduced bid-ask spreads where stocks are
traded in packaged forms. The impact cost will be much lower in case of stock index futures as
opposed to dealing in individual scrips. The market is conditioned to think in terms of the index
and therefore would prefer to trade in stock index futures. Further, the chances of manipulation
are much lesser.
The Stock index futures are expected to be extremely liquid given the speculative
nature of our markets and the overwhelming retail participation expected to be fairly high. In the
near future, stock index futures will definitely see incredible volumes in India. It will be a
blockbuster product and is pitched to become the most liquid contract in the world in terms of
number of contracts traded if not in terms of notional value. The advantage to the equity or cash
market is in the fact that they would become less volatile as most of the speculative activity
would shift to stock index futures. The stock index futures market should ideally have more
depth, volumes and act as a stabilizing factor for the cash market. However, it is too early to base
any conclusions on the volume or to form any firm trend.
The difference between stock index futures and most other financial futures
contracts is that settlement is made at the value of the index at maturity of the contract.

37
Futures terminology :-

a) Spot price : The price at which an asset trades in the spot market
b) Futures price : The price at which the futures contract trades in the futures
market.
c) Contract cycle : The period over which a contract trades. The index futures
contracts on the NSE have one-month, two-month and three-months expiry cycles
which expire on the last Thursday of the month. Thus a January expiration
contract expires on the last Thursday of January and a February expiration
contract trading on the last Thursday of February. On the Friday following the last
Thursday, a new contract having a three-month expiry is introduced for trading.
d) Expiry date : It is the date specified in the futures contract. This is the last day on
which the contract will be traded, at the end of which it will cease to exist.
e) Contract size : The amount of asset that has to be delivered under one contract.
For instance, the contract size on NSE’s futures market is 200 Nifties.
f) Basis :In the context of financial futures, basis can be defined as the futures price
minus the spot price. There will be a different basis for each delivery month for
each contract. In a normal market, basis will be positive. This reflects that futures
prices normally exceed spot prices.
g) Cost of carry : The relationship between futures prices and spot prices can be
summarized in terms of what is known as the cost of carry. This measures the
storage cost plus the interest that is paid to finance the asset less the income
earned on the asset.
h) Margin: Margin is money deposited by the buyer and the seller to ensure the
integrity of the contract. Normally the margin requirement has been designed on
the concept of VAR at 99% levels. Based on the value at risk of the stock/index
margins are calculated. In general margin ranges between 10-50% of the contract
value.

38
 i) Initial margin : The amount that must be deposited in the margin account at the
time a futures contract is first entered into is known as initial margin. Both buyer
and seller are required to make security deposits that are intended to guarantee
that they will infact be able to fulfill their obligation. These deposits are Initial
margins and they are often referred as performance margins. The amount of
margin is roughly 5% to 15% of total purchase price of futures contract
j) Marking-to-market : In the futures market, at the end of each trading day, the
margin account is adjusted to reflect the investor’s gain or loss depending upon
the futures closing price. This is called marking-to-market.
k) Maintenance margin : This is somewhat lower than the initial margin. This is set
to ensure that the balance in the margin account never becomes negative. If the
balance in the margin account falls below the maintenance margin, the investor
receives a margin call and is expected to top up the margin account to the initial
margin level before trading commences on the next day.

PARTIES IN THE FUTURES CONTRACT:

There are two parties in a future contract, the Buyer and the Seller. The buyer of the
futures contract is one who is LONG on the futures contract and the seller of the futures contract
is one who is SHORT on the futures contract.

The pay off for the buyer and the seller of the futures contract are as follows.

Pay off for futures:

A Pay off is the likely profit/loss that would accrue to a market participant with change in
the price of the underlying asset. Futures contracts have linear payoffs. In simple words, it means
that the losses as well as profits, for the buyer and the seller of futures contracts, are unlimited.

PAYOFF FOR A BUYER OF FUTURES:

39
 The pay offs for a person who buys a futures contract is similar to the pay off for a
person who holds an asset. He has potentially unlimited upside as well as downside.
Take the case of a speculator who buys a two-month Nifty index futures contract when
the Nifty stands at 1220. The underlying asset in this case is the Nifty portfolio. When the
index moves up, the long futures position starts making profits and when the index moves
down it starts making losses

P
PROFIT

E
2
F
LOSS E
1

CASE 1:
The buyer bought the future contract at (F); if the futures price goes to E1 then the buyer
gets the profit of (FP).
CASE 2:
The buyer gets loss when the future price goes less than (F), if the futures price goes to
E2 then the buyer gets the loss of (FL).

PAYOFF FOR A SELLER OF FUTURES:

The pay offs for a person who sells a futures contract is similar to the pay off for a
person who shorts an asset. He has potentially unlimited upside as well as downside.
Take the case of a speculator who sells a two-month Nifty index futures contract when the
Nifty stands at 1220. The underlying asset in this case is the Nifty portfolio. When the index

40
 moves down, the short futures position starts making profits and when the index moves up it
starts making losses.

PROFIT

E
2

E F
1

LOSS

F – FUTURES PRICE
E1, E2 – SETTLEMENT PRICE.

CASE 1:
The Seller sold the future contract at (f); if the futures price goes to E1 then the Seller
gets the profit of (FP).

CASE 2:
The Seller gets loss when the future price goes greater than (F), if the futures price goes
to E2 then the Seller gets the loss of (FL).

Pricing the Futures:

The fair value of the futures contract is derived from a model known as the Cost of Carry
model. This model gives the fair value of the futures contract.

Cost of Carry Model:

41
F=S (1+r-q) t
Where

F – Futures Price S – Spot price of the Underlying r – Cost of Financing q – Expected Dividend Yield T – Holding Period.

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

Option Terminology:-
a) Index options: These options have the index as the underlying. Some options are
i. European while others are American. Like index futures contracts, index
options
ii. contracts are also cash settled.
b) Stock options: Stock options are options on individual stocks. Options currently
i. trade on over 500 stocks in the United States. A contract gives the holder
the right to to buy or sell shares
at the specified price.
c) Buyer of an option: The buyer of an option is the one who by paying the option
i. premium buys the right but not the obligation to exercise his option on the
ii. seller/writer.
d) Writer of an option: The writer of a call/put option is the one who receives the
i. option premium and is thereby obliged to sell/buy the asset if the buyer
exercises on
ii. him. There are two basic types of options, call options and put options.
e) Call option: A call option gives the holder the right but not the obligation to buy an asset
by a certain date for a certain price.
f) Put option: A put option gives the holder the right but not the obligation to sell an asset
by a certain date for a certain price.
g) Option price: Option price is the price which the option buyer pays to the option

42
 seller.
h) Expiration date: The date specified in the options contract is known as the
expiration date, the exercise date, the strike date or the maturity.
i) Strike price: The price specified in the options contract is known as the strike price
or the exercise price.
j) American options: American options are options that can be exercised at any time
Up to the expiration date. Most exchange-traded options are American.
k) European options: European options are options that can be exercised only on the
expiration date itself. European options are easier to analyze than
American options, and properties of an American option are frequently
deduced from those of its European counterpart.
l) In-the-money option: An in-the-money (ITM) option is an option that would lead to a
positive cash flow to the holder if it were exercised immediately. A call option on the
index is said to be in-the-money when the current index stands at a level higher than the strike
price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is
said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price.

m) At-the-money option: An at-the-money (ATM) option is an option that would lead

to zero cashflow if it were exercised immediately. An option on the index is at-themoney
when the current index equals the strike price (i.e. spot price = strike price)._

n) Out-of-the-money option: An out-of-the-money (OTM) option is an option that

would lead to a negative cash flow it were exercised immediately. A call option on
the index is out-of- the-money when the current index stands at a level which is less
than the strike price (i.e. spot price < strike price). If the index is much lower than the
strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if
the index is above the strike price.
o) Intrinsic value of an option: The option premium can be broken down into two
components - intrinsic value and time value. The intrinsic value of a call is the
amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero.
Putting it another way, the intrinsic value of a call is N.P which means the intrinsic

43
value of a call is Max [0, (St – K)] which means the intrinsic value of a call is the (St –
K). Similarly, the intrinsic value of a put is Max [0, (K -St )] ,i.e. the greater of 0 or
(K - St ). K is the strike price and St is the spot price.
p) Time value of an option: The time value of an option is the difference between
its premium and its intrinsic value. A call that is OTM or ATM has only time value. Usually, the
maximum time value exists when the option is ATM. The longer the time to expiration, the
greater is a call’s time value, all else equal. At expiration, a call
should have no time value.

TYPES OF OPTION:

 CALL OPTION
A call option gives the holder (buyer/ one who is long call), the right to buy specified
quantity of the underlying asset at the strike price on or before expiration date. The seller (one
who is short call) however, has the obligation to sell the underlying asset if the buyer of the call
option decides to exercise his option to buy. To acquire this right the buyer pays a premium to
the writer (seller) of the contract.

Illustration
Suppose in this option there are two parties one is Mahesh (call buyer) who is bullish
in the market and other is Rakesh (call seller) who is bearish in the market.
The current market price of RELIANCE COMPANY is Rs.600 and premium is Rs.25

1) Call buyer
Here the Mahesh has purchase the call option with a strike price of Rs.600.The option
will be excerised once the price went above 600. The premium paid by the buyer is Rs.25.The
buyer will earn profit once the share price crossed to Rs.625(strike price + premium). Suppose
the stock has crossed Rs.660 the option will be exercised the buyer will purchase the
RELIANCE scrip from the seller at Rs.600 and sell in the market at Rs.660.

44
 Unlimited profit for the buyer = Rs.35{(spot price – strike price) – premium}
Limited loss for the buyer up to the premium paid.

2) Call seller:
In another scenario, if at the tie of expiry stock price falls below Rs. 600 say suppose the
stock price fall to Rs.550 the buyer will choose not to exercise the option.
Profit for the Seller limited to the premium received = Rs.25
Loss unlimited for the seller if price touches above 600 say 630 then the loss of Rs.30
Finally the stock price goes to Rs.610 the buyer will not exercise the option because he has the
lost the premium of Rs.25.So he will buy the share from the seller at Rs.610.

Thus from the above example it shows that option contracts are formed so to avoid the
unlimited losses and have limited losses to the certain extent

Thus call option indicates two positions as follows:

 LONG POSITION
If the investor expects price to rise i.e. bullish in the market he takes a long position by
buying call option.

 SHORT POSITION
If the investor expects price to fall i.e. bearish in the market he takes a short position by
selling call option.

 PUT OPTION
A Put option gives the holder (buyer/ one who is long Put), the right to sell specified
quantity of the underlying asset at the strike price on or before a expiry date. The seller of the put
option (one who is short Put) however, has the obligation to buy the underlying asset at the strike
price if the buyer decides to exercise his option to sell.

45
Illustration
Suppose in this option there are two parties one is Dinesh (put buyer) who is bearish in the
market and other is Amit(put seller) who is bullish in the market.
The current market price of TISCO COMPANY is Rs.800 and premium is Rs.2 0

1) Put buyer(dinesh)
Here the Dinesh has purchase the put option with a strike price of Rs.800.The option
will be excerised once the price went below 800. The premium paid by the buyer is Rs.20.The
buyer’s breakeven point is Rs.780(Strike price – Premium paid). The buyer will earn profit once
the share price crossed below to Rs.780. Suppose the stock has crossed Rs.700 the option will be
exercised the buyer will purchase the RELIANCE scrip from the market at Rs.700and sell to the
seller at Rs.800
Unlimited profit for the buyer = Rs.80 {(Strike price – spot price) – premium}
Loss limited for the buyer up to the premium paid = 20

2) put seller(Amit):
In another scenario, if at the time of expiry, market price of TISCO is Rs. 900. the buyer
of the Put option will choose not to exercise his option to sell as he can sell in the market at a
higher rate.
Unlimited loses for the seller if stock price below 780 say 750 then unlimited losses for
the seller because the seller is bullish in the market = 780 - 750 = 30
Limited profit for the seller up to the premium received = 20

Thus Put option also indicates two positions as follows:

 LONG POSITION
If the investor expects price to fall i.e. bearish in the market he takes a long position by
buying Put option.

 SHORT POSITION

46
 If the investor expects price to rise i.e. bullish in the market he takes a short position by
selling Put option

FACTORS AFFECTING OPTION PREMIUM:

 Price of the underlying asset: (s)

Changes in the underlying asset price can increase or decrease the premium of an option.
These price changes have opposite effects on calls and puts. For instance, as the price of the
underlying asset rises, the premium of a call will increase and the premium of a put will
decrease. A decrease in the price of the underlying asset’s value will generally have the opposite
effect

 Strike price: (k)

The strike price determines whether or not an option has any intrinsic value. An
option’s premium generally increases as the option gets further in the money, and decreases as
the option becomes more deeply out of the money.

 Time until expiration: (t)

An expiration approaches, the level of an option’s time value, for puts and calls,
decreases.

 Volatility:
Volatility is simply a measure of risk (uncertainty), or variability of an option’s
underlying. Higher volatility estimates reflect greater expected fluctuations (in either direction)
in underlying price levels. This expectation generally results in higher option premiums for puts
and calls alike, and is most noticeable with at- the- money options.

 Interest rate: (R1)

This effect reflects the “COST OF CARRY” – the interest that might be paid for
margin, in case of an option seller or received from alternative investments in the case of an

47
option buyer for the premium paid. Higher the interest rate, higher is the premium of the option
as the cost of carry increases.

FUTURES V/S OPTIONS:

Right or obligation :
Futures are agreements/contracts to buy or sell specified quantity of the underlying assets at a
price agreed upon by the buyer & seller, on or before a specified time. Both the buyer and seller
are obligated to buy/sell the underlying asset. In case of options the buyer enjoys the right & not
the obligation, to buy or sell the underlying asset.

Risk:
Futures Contracts have symmetric risk profile for both the buyer as well as the seller.
While options have asymmetric risk profile. In case of Options, for a buyer (or holder of the
option), the downside is limited to the premium (option price) he has paid while the profits may
be unlimited. For a seller or writer of an option, however, the downside is unlimited while profits
are limited to the premium he has received from the buyer.

Prices:
The Futures contracts prices are affected mainly by the prices of the underlying asset.
While the prices of options are however, affected by prices of the underlying asset, time
remaining for expiry of the contract & volatility of the underlying asset.

Cost:
It costs nothing to enter into a futures contract whereas there is a cost of entering into an
options contract, termed as Premium.

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Strike price:
In the Futures contract the strike price moves while in the option contract the strike price
remains constant .

Liquidity:
As Futures contract are more popular as compared to options. Also the premium charged is
high in the options. So there is a limited Liquidity in the options as compared to Futures. There is
no dedicated trading and investors in the options contract.

Price behavior:
The trading in future contract is one-dimensional as the price of future depends upon the price
of the underlying only. While trading in option is two-dimensional as the price of the option
depends upon the price and volatility of the underlying.

Pay off:
As options contract are less active as compared to futures which results into non linear pay
off.
While futures are more active has linear pay off .

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