Professional Documents
Culture Documents
CONTENTS
S.
PAGE
TOPICS
No.
NO.
1.
Executive
Summary 06
2.
......
Company
10
3.
Profile...................
Introduction
16
4.
...................
Need of the Study............................................................................ 17
5.
Literatural
18
6.
Review............................................................................
19
7.
Objective
8.
Study.....................................................................
9.
of
the 20
21
Research
Methodology....................................................................
Limitations
of
Study.........................................................................
1
Options....................................................................................... 32
ii)
Swap.......................................................................................
iv)
5)
Other
Kinds
33
of 34
11.
Derivatives.........................................................
History
12.
Derivatives.........................................................................
Indian Derivative Market .... 38
......
1)
Need
of
Derivatives
in
India
of 35
today....... 39
2) .........................
Myths
i)
39
and
realities
derivatives..................
Derivatives increase speculation and do not serve any
2
about
40
41
Indian
Market
is
not
ready
for
derivative 45
3)
trading.........................
47
4)
5)
Contributing
To
The
Growth
Of
Derivatives........................
Price 47
i)
Volatility..............................................................................
Globalisation
ii)
of 48
Markets..............................................................
49
Technological Advances..............................................................
iii)
Advances
in
Financial 49
iv)
13.
Theories........................................
Development
of
Derivative
14.
India.......
Benifits of Derivatives...................................
1)
Risk
Markets
in 50
54
2 Management............................................................................
)
54
54
Price Discovery..............................................................................
54
3 Operational Advantages.................................................................
55
Market
55
4 Efficiency............................................................................
)
Easy
to
5 Speculation.........................................................................
)
15.
National
59
16.
Exchanges.........................................................................
Present Status.................................................................................
60
17.
Status
18.
Market.................
19.
Business
20.
(NSE).............................
21.
Findings
Report
of
Growth
the
development
in
Derivative 62
69
in
Derivatives
segment 81
82
& 83
Conclusion.....................................................................
Recommendations & Suggestions..................................................
Bibliography
22.
........
Abbrevations................................................................................... 84
EXECUTIVE SUMMARY
Firstly I am briefing the current Indian market and compairing it with it past.
I am also giving brief data about foreign market. Then at the last I am giving
my suggestions and recommendations.
With over 25 million shareholders, India has the third largest investor base in
the world after USA and Japan. Over 7500 companies are listed on the
Indian stock exchanges (more than the number of companies listed in
developed markets of Japan, UK, Germany, France, Australia, Switzerland,
Canada and Hong Kong.). The Indian capital market is significant in terms
of the degree of development, volume of trading, transparency and its
tremendous growth potential.
Indias market capitalization was the highest among the emerging markets.
Total market capitalization of The Bombay Stock Exchange (BSE), which,
as on July 31, 1997, was US$ 175 billion has grown by 37.5% percent every
twelve months and was over US$ 834 billion as of January, 2007. Bombay
Stock Exchanges (BSE), one of the oldest in the world, accounts for the
largest number of listed companies transacting their shares on a nationwide
online trading system. The two major exchanges namely the National Stock
Exchange (NSE) and the Bombay Stock Exchange (BSE) ranked no. 3 & 5
in the world, calculated by the number of daily transactions done on the
exchanges.
The Total Turnover of Indian Financial Markets crossed US$ 2256 billion in
2006 An increase of 82% from US $ 1237 billion in 2004 in a short span
of 2 years only. Turnover in the Spot and Derivatives segment both in NSE
& BSE was higher by 45% into 2006 as compared to 2005. With daily
average volume of US $ 9.4 billion, the Sensex has posted excellent returns
in the recent years. Currently the market cap of the Sensex as on July
4th, 2009 was Rs 48.4 Lakh Crore with a P/E of more than 20.
xtend their settlement through the future contracts. It provides extra liquidity
in the stock market.
Derivatives are assets, which derive their values from an underlying asset.
These underlying assets are of various categories like
Commodities including grains, coffee beans, etc.
Precious metals like gold and silver.
Foreign exchange rate.
Bonds of different types, including medium to long-term negotiable debt
securities issued by governments, companies, etc.
Short-term debt securities such as T-bills.
Over-The-Counter (OTC) money market products such as loans or
deposits.
Equities
For example, a dollar forward is a derivative contract, which gives the buyer
a right & an obligation to buy dollars at some future date. The prices of the
derivatives are driven by the spot prices of these underlying assets.
However, the most important use of derivatives is in transferring market
risk, called Hedging, which is a protection against losses resulting from
unforeseen price or volatility changes. Thus, derivatives are a very important
tool of risk management.
An Options contract confers the right but not the obligation to buy (call
option) or sell (put option) a specified underlying instrument or asset at a
specified price the Strike or Exercised price up until or an specified future
date the Expiry date. The Price is called Premium and is paid by buyer of
the option to the seller or writer of the option.
A call option gives the holder the right to buy an underlying asset by a
certain date for a certain price. The seller is under an obligation to fulfill the
contract and is paid a price of this, which is called "the call option premium
or call option price".
A put option, on the other hand gives the holder the right to sell an
underlying asset by a certain date for a certain price. The buyer is under an
obligation to fulfill the contract and is paid a price for this, which is called
"the put option premium or put option price".
Swaps are transactions which obligates the two parties to the contract to
exchange a series of cash flows at specified intervals known as payment or
settlement dates. They can be regarded as portfolios of forward's contracts. A
contract whereby two parties agree to exchange (swap) payments, based on
10
11
COMPANY PROFILE
12
Vision
To become a long term prefferd long term financial to a wide base of
customer whilst optimizing Stake holder value.
Mission
To establish a base of 1 million satisfied customer by 2010
We will crest this by being a responsible trustworthy partner.
Corporate action
An approach to business that reflects responsibility, transparency and ethical
behaviour.
Respect for employee client and stake holder group.
13
Retail Business
Retail offerings of IIL seek to cover all financial
planning requirements of individuals, which
include
providing
management
personalised
services
including
investment
planning,
Advisory
Services:
Trading
Services:
15
Institutional Business
IILs Institutional business thrives on the strong relationships we have built among
domestic mutual funds, banks, financial institutions, insurance companies and
private sector funds over the past few years. Efficient execution, quality research
and high degree of compliance with stock exchange regulations and ethical
business standards back IILs services to institutional investors.
Our Institutional services can be broadly categorized as follows.
Merchant
Banking
Equity
&
Debt
17
18
SmartExposure
Increase your Market Exposure
19
is
offered
against
the
SmartCall
Convenience to trade over the
phone
SmartSecure
State-of-the-art Security Platforms
State-of-the-Art
Security
Platforms
At IL&FS Investsmart, we place a
very high onus on security and
realize that it is one of the vital
components
of
any
e-business
20
on
state-of-the-art
security platforms.
SmartAlert
Smart Alert Service
SmartNext
Sell Receivable Shares
is
Investsmart
facility
online
offered
by
wherein
the
21
thus
increasing
his
liquidity.
INTRODUCTION
A Derivative is a financial instrument whose value depends on other,
more basic, underlying variables. The variables underlying could be
prices of traded securities and stock, prices of gold or copper.
Derivatives have become increasingly important in the field of finance,
Options and Futures are traded actively on many exchanges, Forward
contracts, Swap and different types of options are regularly traded outside
exchanges by financial intuitions, banks and their corporate clients in
what are termed as over-the-counter markets in other words, there is no
single market place or organized exchanges.
22
The study has been done to know the different types of derivatives and
also to know the derivative market in India. This study also covers the
recent developments in the derivative market taking into account the
trading in past years.
Through this study I came to know the trading done in derivatives and
their use in the stock markets.
23
LITERATURE REVIEW
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
24
25
26
The project covers the derivatives market and its instruments. For better
understanding various strategies with different situations and actions
have been given. It includes the data collected in the recent years and also
the market in the derivatives in the recent years. This study extends to the
trading of derivatives done in the National Stock Markets.
27
RESARCH METHODOLOGY
Method of data collection:Secondary sources:It is the data which has already been collected by some one or an
organization for some other purpose or research study .The data for study
has been collected from various sources:
Books
Journals
Magazines
Internet sources
Time:
2 months
Statistical Tools Used:
Simple tools like bar graphs, tabulation, line diagrams have been used.
28
LIMITAITONS OF STUDY
1. LIMITED TIME:
The time available to conduct the study was only 2 months. It being a
wide topic had a limited time.
2. LIMITED RESOURCES:
Limited resources are available to collect the information about the
commodity trading.
3. VOLATALITY:
Share market is so much volatile and it is difficult to forecast any thing
about it whether you trade through online or offline
29
4. ASPECTS COVERAGE:
Some of the aspects may not be covered in my study.
30
The origin of derivatives can be traced back to the need of farmers to protect
themselves against fluctuations in the price of their crop. From the time it
was sown to the time it was ready for harvest, farmers would face price
uncertainty. Through the use of simple derivative products, it was possible
for the farmer to partially or fully transfer price risks by locking-in asset
prices. These were simple contracts developed to meet the needs of farmers
and were basically a means of reducing risk.
A farmer who sowed his crop in June faced uncertainty over the price
he would receive for his harvest in September. In years of scarcity, he would
probably obtain attractive prices. However, during times of oversupply, he
would have to dispose off his harvest at a very low price. Clearly this meant
that the farmer and his family were exposed to a high risk of price
uncertainty.
31
2. DERIVATIVE DEFINED
A derivative is a product whose value is derived from the value of one or
more underlying variables or assets in a contractual manner. The underlying
32
asset can be equity, forex, commodity or any other asset. In our earlier
discussion, we saw that wheat farmers may wish to sell their harvest at a
future date to eliminate the risk of change in price 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 this case.
The Forwards Contracts (Regulation) Act, 1952, regulates the
forward/futures contracts in commodities all over India. As per this the
Forward Markets Commission (FMC) continues to have jurisdiction over
commodity futures contracts. However when derivatives trading in securities
was introduced in 2001, the term security in the Securities Contracts
(Regulation) Act, 1956 (SCRA), was amended to include derivative
contracts in securities. Consequently, regulation of derivatives came under
the purview of Securities Exchange Board of India (SEBI). We thus have
separate regulatory authorities for securities and commodity derivative
markets.
Derivatives are securities under the SCRA and hence the trading of
derivatives is governed by the regulatory framework under the SCRA. The
Securities Contracts (Regulation) Act, 1956 defines derivative to include-
33
National Stock
Bombay Stock
National
Commodity &
Exchange
Exchange
Exchange
34
Derivative
Index Future
Index option
Stock option
Stock future
4. TYPES OF DERIVATIVES
Derivatives
Future
Option
Forward
35
Swaps
(i)
FORWARD CONTRACTS
36
markets have
become very
as
they
improvement
eliminate counterparty
risk
offer
more
liquidity.
(ii)
FUTURE CONTRACT
37
The settlement price, normally, converges towards the futures price on the
delivery date.
A futures contract gives the holder the right and the obligation to buy or sell,
which differs from an options contract, which gives the buyer the right, but
not the obligation, and the option writer (seller) the obligation, but not the
right. To exit the commitment, the holder of a futures position has to sell his
long position or buy back his short position, effectively closing out the
futures position and its contract obligations. Futures contracts are exchange
traded derivatives. The exchange acts as counterparty on all contracts, sets
margin requirements, etc.
BASIC FEATURES OF FUTURE CONTRACT
1. Standardization:
Futures contracts ensure their liquidity by being highly standardized, usually
by specifying:
The underlying. This can be anything from a barrel of sweet crude oil
to a short term interest rate.
The type of settlement, either cash settlement or physical settlement.
38
The amount and units of the underlying asset per contract. This can be
the notional amount of bonds, a fixed number of barrels of oil, units of
foreign currency, the notional amount of the deposit over which the
short term interest rate is traded, etc.
The currency in which the futures contract is quoted.
The grade of the deliverable. In case of bonds, this specifies which
bonds can be delivered. In case of physical commodities, this specifies
not only the quality of the underlying goods but also the manner and
location of delivery. The delivery month.
The last trading date.
Other details such as the tick, the minimum permissible price
fluctuation.
2. Margin:
Although the value of a contract at time of trading should be zero, its price
constantly fluctuates. This renders the owner liable to adverse changes in
value, and creates a credit risk to the exchange, who always acts as
counterparty. To minimize this risk, the exchange demands that contract
owners post a form of collateral, commonly known as Margin requirements
are waived or reduced in some cases for hedgers who have physical
39
40
3. Settlement
Settlement is the act of consummating the contract, and can be done in one
of two ways, as specified per type of futures contract:
41
at
42
43
FEATURE
FORWARD
FUTURE CONTRACT
Operational
CONTRACT
Traded directly between Traded on the exchanges.
Mechanism
Contract
on the exchanges).
Differ from trade
Specifications
Counter-party
trade.
Exists.
to Contracts
are
standardized
contracts.
Exists. However, assumed by the
risk
Liquidation
settlement.
Low, as contracts are High,
as
Profile
tailor
made
contracts
contracts standardized
exchange
are
traded
as
markets
are
44
come
to
common
Examples
Currency
market
in Commodities,
India.
Futures
and
Futures in India.
45
futures,
Index
Individual
stock
OPTIONS A derivative transaction that gives the option holder the right but not the
obligation to buy or sell the underlying asset at a price, called the strike
price, during a period or on a specific date in exchange for payment of a
premium is known as option. Underlying asset refers to any asset that is
traded. The price at which the underlying is traded is called the strike price.
There are two types of options i.e., CALL OPTION & PUT OPTION.
CALL OPTION:
A contract that gives its owner the right but not the obligation to buy an
underlying asset-stock or any financial asset, at a specified price on or before
a specified date is known as a Call option. The owner makes a profit
provided he sells at a higher current price and buys at a lower future price.
PUT OPTION:
A contract that gives its owner the right but not the obligation to sell an
underlying asset-stock or any financial asset, at a specified price on or before
46
Put and calls are almost always written on equities, although occasionally
preference shares, bonds and warrants become the subject of options.
47
SWAPS Swaps are transactions which obligates the two parties to the contract to
exchange a series of cash flows at specified intervals known as payment or
settlement dates. They can be regarded as portfolios of forward's contracts. A
contract whereby two parties agree to exchange (swap) payments, based on
some notional principle amount is called as a SWAP. In case of swap, only
the payment flows are exchanged and not the principle amount. The two
commonly used swaps are:
CURRENCY SWAPS:
Currency swaps is an arrangement in which both the principle amount and
the interest on loan in one currency are swapped for the principle and the
48
FINANCIAL SWAP:
Financial swaps constitute a funding technique which permit a borrower to
access one market and then exchange the liability for another type of
liability. It also allows the investors to exchange one type of asset for
another type of asset with a preferred income stream.
49
BASKETS -
LEAPS -
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. Longerdated options are called warrants and are generally traded over-the-counter.
SWAPTIONS -
50
Swaptions are options to buy or sell a swap that will become operative at the
expiry of the options. Thus a swaption is an option on a forward swap.
Rather than have calls and puts, the swaptions market has receiver swaptions
and payer swaptions. A receiver swaption is an option to receive fixed and
pay floating. A payer swaption is an option to pay fixed and receive floating.
51
52
Options are as old as futures. Their history also dates back to ancient Greece
and Rome. Options are very popular with speculators in the tulip craze of
seventeenth century Holland. Tulips, the brightly coloured flowers, were a
53
symbol of affluence; owing to a high demand, tulip bulb prices shot up.
Dutch growers and dealers traded in tulip bulb options. There was so much
speculation that people even mortgaged their homes and businesses. These
speculators were wiped out when the tulip craze collapsed in 1637 as there
was no mechanism to guarantee the performance of the option terms.
The first call and put options were invented by an
American financier, Russell Sage, in 1872. These options were traded over
the counter. Agricultural commodities options were traded in the nineteenth
century in England and the US. Options on shares were available in the US
on the over the counter (OTC) market only until 1973 without much
knowledge of valuation. A group of firms known as Put and Call brokers and
Dealers Association was set up in early 1900s to provide a mechanism for
bringing buyers and sellers together.
On April 26, 1973, the Chicago Board options Exchange
(CBOE) was set up at CBOT for the purpose of trading stock options. It was
in 1973 again that black, Merton, and Scholes invented the famous BlackScholes Option Formula. This model helped in assessing the fair price of an
option which led to an increased interest in trading of options. With the
options markets becoming increasingly popular, the American Stock
54
The market for futures and options grew at a rapid pace in the eighties and
nineties. The collapse of the Bretton Woods regime of fixed parties and the
introduction of floating rates for currencies in the international financial
markets paved the way for development of a number of financial derivatives
which served as effective risk management tools to cope with market
uncertainties.
The CBOT and the CME are two largest financial exchanges in the world on
which futures contracts are traded. The CBOT now offers 48 futures and
option contracts (with the annual volume at more than 211 million in
2001).The CBOE is the largest exchange for trading stock options. The
CBOE trades options on the S&P 100 and the S&P 500 stock indices. The
Philadelphia Stock Exchange is the premier exchange for trading foreign
options.
The most traded stock indices include S&P 500, the Dow Jones
Industrial Average, the Nasdaq 100, and the Nikkei 225. The US indices and
55
the Nikkei 225 trade almost round the clock. The N225 is also traded on the
Chicago Mercantile Exchange.
56
24 May 2000
25 May 2000
on an Indian index.
SEBI gave permission to NSE and BSE to do index
9 June 2000
12 June 2000
futures trading.
Trading of BSE Sensex futures commenced at BSE.
Trading of Nifty futures commenced at NSE.
57
25
2000
2 June 2001
part
of
the
world.
Until the advent of NSE, the Indian capital market had no access to the latest
trading methods and was using traditional out-dated methods of trading.
There was a huge gap between the investors aspirations of the markets and
the available means of trading. The opening of Indian economy has
precipitated the process of integration of Indias financial markets with the
international financial markets. Introduction of risk management instruments
in India has gained momentum in last few years thanks to Reserve Bank of
58
59
Disasters prove that derivatives are very risky and highly leveraged
instruments.
Derivatives are complex and exotic instruments that Indian investors
will find difficulty in understanding
Is the existing capital market safer than Derivatives?
(i) Derivatives increase speculation and do not serve any economicpurpose:
Numerous studies of derivatives activity have led to a broad consensus, both
in the private and public sectors that derivatives provide numerous and
substantial benefits to the users. Derivatives are a low-cost, effective method
for users to hedge and manage their exposures to interest rates, commodity
prices or exchange rates. The need for derivatives as hedging tool was felt
first in the commodities market. Agricultural futures and options helped
farmers and processors hedge against commodity price risk. After the fallout
of Bretton wood agreement, the financial markets in the world started
undergoing radical changes. This period is marked by remarkable
innovations in the financial markets such as introduction of floating rates for
the currencies, increased trading in variety of derivatives instruments, online trading in the capital markets, etc. As the complexity of instruments
increased many folds, the accompanying risk factors grew in gigantic
60
61
Often the argument put forth against derivatives trading is that the Indian
capital market is not ready for derivatives trading. Here, we look into the
pre-requisites, which are needed for the introduction of derivatives, and how
Indian market fares:
TABLE 3.
PRE-REQUISITES
INDIAN SCENARIO
Large
market India is one of the largest market-capitalised
Capitalisation
Trade guarantee
National
Securities
Depositories
Limited
The figure 3.3a 3.3d shows how advantages of new system (implemented
from June 20001) v/s the old system i.e. before June 2001
New System Vs Existing System for Market Players
Figure 3.3a
Speculators
Existing
Approach
SYSTEM
1) Deliver based
New
Peril &Prize
1)Buy &Sell stocks
1)Maximum
Trading, margin
loss to extent of
on delivery basis
loss
price change.
to
possible
trading & carry
premium
forward transactions.
by paying
64
paid
premium
Figure 3.3b
Arbitrageurs
Existing
SYSTEM
65
New
Approach
Peril &Prize
Approach
Peril &Prize
1) B Group more
1) Risk free
promising as still
game.
whichever way
another exchange.
forward transactions.
in weekly settlement
2) Cash &Carry
2) If Future Contract
arbitrage continues
Figure 3.3c
Hedgers
Existing
SYSTEM
66
New
Approach
Peril &Prize
1) Difficult to
Approach
1) No Leverage
Peril &Prize
1)Fix price today to buy
1)
Additional
offload holding
available risk
cost is only
during adverse
reward dependant
premium.
market conditions
on market prices
as circuit filters
prcie
Advantages
Availability of Leverage
Figure 3.3d
Small Investors
67
Existing
Approach
SYSTEM
Peril &Prize
1) If Bullish buy
Approach
1) Plain Buy/Sell
New
Peril &Prize
1) Buy Call/Put options
1)
Downside
stocks else sell it.
implies unlimited
remains
profit/loss.
2) Hedge position if
protected &
holding underlying
upside
stock
unlimited.
Advantages
Losses Protected.
68
69
70
exposures. When asset prices change rapidly, the size and configuration of
counter-party exposures can become unsustainably large and provoke a rapid
unwinding of positions.
There has been some progress in addressing these risks and perceptions.
However, the progress has been limited in implementing reforms in risk
management, including counter-party, liquidity and operational risks, and
OTC derivatives markets continue to pose a threat to international financial
stability. The problem is more acute as heavy reliance on OTC derivatives
creates the possibility of systemic financial events, which fall outside the
more formal clearing house structures. Moreover, those who provide OTC
derivative products, hedge their risks through the use of exchange traded
derivatives. In view of the inherent risks associated with OTC derivatives,
and their dependence on exchange traded derivatives, Indian law considers
them illegal.
71
72
73
the markets. Information which would have taken months to impact the
market earlier can now be obtained in matter of moments.
Even equity holders are exposed to price risk of corporate share fluctuates
rapidly.
These price volatility risks pushed the use of derivatives like futures and
options increasingly as these instruments can be used as hedge to protect
against adverse price changes in commodity, foreign exchange, equity shares
and bonds.
In Indian context, south East Asian currencies crisis of 1997 had affected the
competitiveness of our products vis--vis depreciated currencies. Export of
certain goods from India declined because of this crisis. Steel industry in
74
1998 suffered its worst set back due to cheap import of steel from south East
Asian countries. Suddenly blue chip companies had turned in to red. The
fear of china devaluing its currency created instability in Indian exports.
Thus, it is evident that globalisation of industrial and financial activities
necessitates use of derivatives to guard against future losses. This factor
alone has contributed to the growth of derivatives to a significant extent.
Improvement
in
communications
allow
for
75
76
The first step towards introduction of derivatives trading in India was the
promulgation of the Securities Laws (Amendment) Ordinance, 1995, which
withdrew the prohibition on options in securities. The market for derivatives,
however, did not take off, as there was no regulatory framework to govern
trading of derivatives. SEBI set up a 24member committee under the
Chairmanship of Dr.L.C.Gupta on November 18, 1996 to develop
appropriate regulatory framework for derivatives trading in India. The
committee submitted its report on March 17, 1998 prescribing necessary
preconditions for introduction of derivatives trading in India. The
committee recommended that derivatives should be declared as securities
so that regulatory framework applicable to trading of securities could also
govern trading of securities. SEBI also set up a group in June 1998 under the
Chairmanship of Prof.J.R.Varma, to recommend measures for risk
containment in derivatives market in India. The report, which was submitted
in October 1998, worked out the operational details of margining system,
methodology for charging initial margins, broker net worth, deposit
requirement and realtime monitoring requirements. The Securities Contract
Regulation Act (SCRA) was amended in December 1999 to include
77
The trading in BSE Sensex options commenced on June 4, 2001 and the
trading in options on individual securities commenced in July 2001. Futures
contracts on individual stocks were launched in November 2001. The
derivatives trading on NSE commenced with S&P CNX Nifty Index futures
on June 12, 2000. The trading in index options commenced on June 4, 2001
78
The following are some observations based on the trading statistics provided
in the NSE report on the futures and options (F&O):
F&O segment. It constituted 70 per cent of the total turnover during June
2002. A primary reason attributed to this phenomenon is that traders are
comfortable with single-stock futures than equity options, as the former
closely resembles the erstwhile badla system.
remain poor. This may be due to the low volatility of the spot index.
79
Typically, options are considered more valuable when the volatility of the
underlying (in this case, the index) is high. A related issue is that brokers do
not earn high commissions by recommending index options to their clients,
because low volatility leads to higher waiting time for round-trips.
Put volumes in the index options and equity options segment have
increased since January 2002. The call-put volumes in index options have
decreased from 2.86 in January 2002 to 1.32 in June. The fall in call-put
volumes ratio suggests that the traders are increasingly becoming pessimistic
on the market.
Farther month futures contracts are still not actively traded. Trading in
equity options on most stocks for even the next month was non-existent.
Daily option price variations suggest that traders use the F&O
80
segment but the derivative segment has also grown. In the derivative
market foreign exchange swaps account for the largest share of the
total turnover of derivatives in India followed by forwards and
options. Significant milestones in the development of derivatives market
have been (i) permission to banks to undertake cross currency derivative
transactions subject to certain conditions (1996) (ii) allowing corporates
to undertake long term foreign currency swaps that contributed to
the development of the term currency swap market (1997) (iii) allowing
dollar rupee options (2003) and (iv) introduction of currency futures
(2008). I would like to emphasise that currency swaps allowed
companies with ECBs to swap their foreign currency liabilities into
rupees. However, since banks could not carry open positions the risk was
allowed to be transferred to any other resident corporate. Normally such
risks should be taken by corporates who have natural hedge or have
potential foreign exchange earnings.
81
liberalisation
in capital account
currency a separate asset class that can be traded without any underlying
need or exposure a n d on a leveraged basis on the recognized stock
exchanges with credit risks being assumed by the central counterparty
Since the commencement of trading of currency futures in all the three
exchanges, the value of the trades has gone up steadily from Rs 17, 429
crores in October 2008 to Rs 45, 803 crores in December 2008. The
average daily turnover in all the exchanges has also increased from
Rs871 crores to Rs 2,181 crores during the same period. The turnover in
the currency futures market is in line with the international scenario,
where I understand the share of futures market ranges between 2 3 per
cent.
Table 4.1ForexMarketActivity
82
April08-
Mar06
4,404
Mar07
6,571
Mar08
12,304
Dec08
9,621
2.6:1
2.7:1
2.37: 1
2.66:1
50.5
51.9
49.7
45.9
19.0
17.9
19.3
21.5
30.5
30.1
31.1
32.7
Source: RBI
RISK MANAGEMENT
Futures and options contract can be used for altering the risk of investing in
spot market. For instance, consider an investor who owns an asset. He will
always be worried that the price may fall before he can sell the asset. He can
protect himself by selling a futures contract, or by buying a Put option. If the
spot price falls, the short hedgers will gain in the futures market, as you will
see later. This will help offset their losses in the spot market. Similarly, if the
spot price falls below the exercise price, the put option can always be
exercised.
2.]
PRICE DISCOVERY
83
OPERATIONAL ADVANTAGES
84
4.]
MARKET EFFICIENCY
5.]
EASE OF SPECULATION
85
86
MCX
MCX (Multi Commodity Exchange of India Ltd.) an independent
and de-mutulised multi commodity exchange has permanent recognition
from Government of India for facilitating online trading, clearing and
settlement operations for commodity futures markets across the country. Key
shareholders of MCX are Financial Technologies (India) Ltd., State Bank of
India, HDFC Bank, State Bank of Indore, State Bank of Hyderabad, State
Bank of Saurashtra, SBI Life Insurance Co. Ltd., Union Bank of India, Bank
of
India, Bank of
Baroda,
Canera
Bank,
Corporation
Bank
87
by
Central
Warehousing
Corporation
(CWC),
National
88
vital missing link. Punjab National Bank (PNB) took equity of the Exchange
to establish that linkage. Even today, NMCE is the only Exchange in India to
have such investment and technical support from the commodity relevant
institutions.
89
clearing and settlement is held. NMCE was the first to initiate process of
dematerialization and electronic transfer of warehoused commodity stocks.
The unique strength of NMCE is its settlements via a Delivery Backed
System, an imperative in the commodity trading business. These deliveries
are executed through a sound and reliable Warehouse Receipt System,
leading to guaranteed clearing and settlement.
NCDEX
National Commodity and Derivatives Exchange Ltd (NCDEX) is a
technology driven commodity exchange. It is a public limited company
registered under the Companies Act, 1956 with the Registrar of Companies,
Maharashtra in Mumbai on April 23,2003. It has an independent Board of
Directors and professionals not having any vested interest in commodity
markets. It has been launched to provide a world-class commodity exchange
platform for market participants to trade in a wide spectrum of commodity
derivatives
driven
by
best
global
practices,
professionalism
and
transparency.
90
laws of the land like the Companies Act, Stamp Act, Contracts Act, Forward
Commission (Regulation) Act and various other legislations, which impinge
on its working. It is located in Mumbai and offers facilities to its members in
more than 390 centres throughout India. The reach will gradually be
expanded
to
more
centres.
91
92
No.
1.
Exchange
COMMODITY
India Pepper & Spice Trade Pepper (both domestic
Association, Kochi (IPSTA)
and
international
2.
contracts)
Vijai Beopar Chambers Ltd., Gur, Mustard seed
3.
Muzaffarnagar
Rajdhani Oils
4.
&
Ltd.,
5.
Bhatinda
The Chamber
6.
Hapur
Mustard seed
The Meerut Agro Commodities Gur
7.
8.
of
Commerce, Gur,
93
Potatoes
and
palmolein.
Commodity Castorseed,
and
9.
The
10.
Exchange, Ahmedabad
its oil and oilcake
The East India Jute & Hessian Hessian & Sacking
11.
12.
13.
Ltd., Sangli.
National Board of Trade, Indore
RBD
cottonseed,
Cotton Cotton
meals,
Rapeseed/Mustardseed its
oil and oilcake and RBD
14.
Palmolien
The First Commodities Exchange Copra/coconut, its oil &
15.
16.
17.
18.
of
India
Ltd.,
Ahmedabad
Coffee Futures Exchange India Coffee
94
19.
Ltd., Bangalore
Surendranagar Cotton
20.
Oilseeds, Surendranagar
E-Commodities Ltd., New Delhi
21.
National
Oil
Commodity
Derivatives,
Exchange
& Cotton,
Cottonseed,
Kapas
Sugar (trading yet to
commence)
& Several Commodities
Ltd.,
22.
Mumbai
Multi Commodity Exchange Ltd., Several Commodities
23.
Mumbai
Bikaner commodity
Ltd., Bikaner
24.
Haryana
Commodities
Hissar
25.
Bullion Association Ltd., Jaipur
Mustard seed Complex
17. STATUS REPORT OF THE DEVELOPMENTS IN THE DERIVATIVE
MARKET
1. The Board at its meeting on November 29, 2002 had desired that a
quarterly report be
95
Refer Table 1
This mainly
96
the
derivatives
Refer Table 2
Refer Table 3
97
Refer Table 4
Refer Table 5
Refer Table 6
98
2008.
Market Depth
quarter
PRODUCT
APRIL-JUNE 2008-09
No.
of Turnover
JULY-SEPTEMBER2008-09
No.
of Turnover
Contracts(
Contracts(Lak
(Rs. 000)
Lakh)
VOLUME & TURNOVER
Index Future
415.7
h)
935.
6
571.
240.1
Stock
1,077.
542.6
Index Option
Single
(Rs. 000)
5
1,130.
521.2
3
1,093.
514.5
99
599.0
9
1,039.
Depth
Future
Stock Option
Total
1
25.5
58.3
2,658.
1,195.8
35.9
69.1
3,317.
1,698.7
4
Market Share ( %)
Index Future
35.2
1,077.5
31.94
0
21.4
Index Option
8
34.0
30.68
1,130.9
Single
32.4
9
41.1
Stock
Future
Stock Option
69.1
Turnover in F&O as
9
31.3
35.26
1,039.3
2
2.19
2.11
3
2.08
multiple of turnover in
4.19
Market Concentration
cash segment
3.26
Five
- Reliance
- Tata Steel
most
active scrips in
the
F&O
Segment active
scrips
- Reliance
in
the
F&O Segment
100
Contribution
of
five
the above
to total
derivatives
23.72
25.12
turnover (%)
Client
(excluding FII
59.77
60.17
trades)
Proprietary
27.88
31.07
FII
12.35
8.76
Table-6: Data for Shorter Dated and Longer Dated derivative contracts
Time
Period
Trades in Shorter
101
contracts
(up
Months)
No
(more
of
No
of
Turnover
Turnover
contracts
July-
contracts
September
Apr-Jun 20081,194.97
2,655.88
4.83
Time
Period No
of Turnover (Rs.
contract
JulySeptember
102
12.5
Apr-Jun 200829.4
103
27.7
Average
Maximum
Minimum
April-08
May-08
June-08
July-08
August-08
2.47
1.71
1.80
2.85
2.27
2.98
1.99
2.28
3.08
September-
2.2
2.5
1
08
2.6
2.05
1.56
1.61
2.38
2.10
2.09
104
NSE
Volume
SGX
Volume
Month
July-
September
Apr-Jun
2008-
105
SGX
as
volume
Septembe
r
Products
July 2008
Stock
1 August 2008
1
2
Index
2
2
2
Future
Stock
9
15
16
Future
Index
4
4
4
Option
Option
Source: www.world-exchanges.org (as on November 10, 2008)
106
107
Except Index Option, the market share of all other products has
decreased (both in terms of volume and turnover) in second quarter
of 2008-09 as compared to the first quarter of 2008-09.
108
109
No. of contracts
2008-09
4116649
2007-08
156598579
2006-07
81487424
2005-06
58537886
2004-05
21635449
2003-04
17191668
2002-03
2126763
2001-02
1025588
110
INTERPRETATION: From the data and the bar diagram above, there is
high business growth in the derivative segment in India. In the year 2001-02,
the number of contracts in Index Future were 1025588 where as a significant
increase of 4116679 is observed in the year 2008-09.
2008-09
925679.96
2007-08
3820667.27
2006-07
2539574
2005-06
1513755
2004-05
772147
111
2003-04
554446
2002-03
43952
2001-02
21483
INTERPRETATION:
From the data and above bar chart, there is high turn over in the derivative
segment in India. In the year 2001-02 the turnover of index future was
21483 where as a huge increase of 92567996 in the year 2008-09 are
observed.
112
No. of contracts
51449737
203587952
104955401
80905493
47043066
32368842
10676843
1957856
-
INTERPRETATION:
From the data and bar diagram above there were no stock futures available
but in the year 2001-02, it predominently increased to 1957856. Then there
113
was a huge increase of 20, 35, and 87,952 in the year 2007-08 but there was
a steady decline to 51449737 in the year 2008-09.
Turnover
(Rs. Crores)
2008-09
1093048.26
2007-08
7548563.23
2006-07
3830967
2005-06
2791697
2004-05
1484056
2003-04
1305939
2002-03
286533
2001-02
51515
2000-01
FIGURE 12B Turnover in Rs. Crores
114
INTERPRETATION:
From the data and bar chart above, there were no stock futures available in
the year 2000-01. There was a steady increase of stock future 51515 in the
year 2001-02. but in the year there was a huge increae of 7548563.23 in the
year 2007-08 with a considerable decline of 1093048.26 in the year 2008-09.
No. of contracts
24008627
55366038
25157438
12935116
3293558
1732414
442241
175900
-
115
Interpretation:
From the data and bar chart above, the no of contracts of index option was
nil in the year 2000-2001. But there was a predominant increase of 1,75,900
in the year 2001-2002. In the year 2007-2008 there was a huge increase in
the index option contracts to 55366038 and a decline of 24008627 in the
year 2008-2009.
Turnover
Year
2008-09
2007-08
Crores)
71340.02
1362110.88
116
(Rs.
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01
791906
338469
121943
52816
9246
3765
-
Interpretation:
From the data and bar chart above, there was no turnover in the year 20002001 for Index option. It slowly started increasing in the year 2000-2001 to
3765.But in the year 2007-2008 there was a huge increase of 1362110.088
and a sudden decline to 71340.02 observed in 2008-2009.
117
No. of contracts
2546175
9460631
5283310
5240776
5045112
5583071
3523062
1037529
-
INTERPRETATION:
From the data and bar chart above the no of contracts of stock option in the
year 2000-2001 was nil. But there was a huge increase of 1037529 observed
118
in the year 2001-2002. It was 9460631 which was the the highest in the year
2007-2008. But a gradual decline of 2546175 in the year 2008-2009.
Notional
2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01
crores)
58335.03
359136.55
193795
180253
168836
217207
100131
25163
-
turnover
119
(Rs.
Interpretation:
From the chart and the bar diagram above the stock option turnover in the
year 2000-2001 was nil. There was a slow increase of 25163 in the year
2001-2002. But a phenomenal increase of 359136.55 in the year 2007-2008,
and a decline of 58355.03 in the year 2008-2009.
No. of contracts
119171008
425013200
216883573
157619271
77017185
56886776
16768909
120
2001-02
2000-01
4196873
90580
101926
2365
Interpretation:
From the data and bar chart above, the overall trading contracts in the year
2000-2001 was 90580 and huge increase of 119171008 in the year 20082009.
From the data and bar chart above the overall trading turnover in the year
2000-2001 was as low as 2365 but a predominant increase of 2648403.30
observed in the year 2008-2009.
121
Stock
Index
Stock
Rate
Total
Futures
Futures
Options
Options
Future
s
No. Tu No.
Y No.
Turno No.
Turno No.
Notio
No.
Notio
ver
of
ver
of
nal
of
nal
a cont
(Rs.
contr
(Rs.
Turno co
r ract
cr.)
acts
cr.)
acts
ver
ntr er
(Rs.
(Rs.
act (R
cr.)
cr.)
s.
cr.
of
ver
acts
of rn
T
of u
ov contra
cts
r
n
(
R
s
.
c
122
r
.
92567
)
2
9.96
2
4
0
8
0
41166
51449
10930
2400
57134
25461
58335.
0.
119171 4
0
469
737
48.26
8627
0.02
75
03
00 008
3
0
.
9
3
2 15659
38206
20358
75485
5536
13621
94606
35913
0 8579
67.27
7952
63.23
6038
10.88
31
6.55
0.
0
425013 1
00 200
7
7
123
.
7
2
5
7
5
81487
25395
10495
38309
2515
79190
52833
19379
216883
0
424
74
5401
67
7438
10
6
573
7
2
2
4
2
58537
15137
80905
27916
1293
33846
52407
18025
157619
0
886
55
493
97
5116
76
4
271
6
2 21635
77214
47043
14840
3293
12194
50451
16883
0 449
066
56
558
12
4
770171 2
85
9
124
5
2
2
2
10
17191
55444
32368
13059
1732
55830
21720
52816
668
842
39
414
3
20 568867
78
71
0
2
76
4
2
0
4
0
3
0
21267
2
10676
28653
4422
43952
63
35230
10013
9246
843
41
167689 9
-
62
09
6
0
2
3
2 10255
0 88
21483
19578
56
51515
1759
3765
00
10375
29
25163
419687 1
3
6
125
2
2
0
2
0
3
0 90580
2365
90580
6
5
0
1
Av.
daily
2008-09
Crores)
45390.21
2007-08
2006-07
52153.30
29543
2005-06
2004-05
2003-04
19220
10167
8388
2002-03
2001-02
1752
410126
2000-01
11
turnover
(Rs.
Note:
Notional Turnover = (Strike Price + Premium) * Quantity
Index Futures, Index Options, Stock Options and Stock Futures were
introduced in June 2000, June 2001, July 2001 and November 2001
respectively.
127
128
2. After analyzing data it is clear that the main factors that are driving
the growth of Derivative Market are Market improvement in
communication facilities as well as long term saving & investment is
also possible through entering into Derivative Contract. So these
factors encourage the Derivative Market in India.
3. It encourages entrepreneurship in India. It encourages the investor to
take more risk & earn more return. So in this way it helps the Indian
Economy by developing entrepreneurship. Derivative Market is more
regulated & standardized so in this way it provides a more controlled
environment. In nutshell, we can say that the rule of High risk & High
return apply in Derivatives. If we are able to take more risk then we
can earn more profit under Derivatives.
129
scale. Only forwards and futures trading are permitted in certain commodity
items.
RELIANCE is the most active future contracts on individual
securities traded with 90090 contracts and RNRL is the next most active
futures contracts with 63522 contracts being traded.
130
131
BIBLIOGRAPHY
Books referred:
Options Futures, and other Derivatives by John C Hull
Derivatives FAQ by Ajay Shah
NSEs Certification in Financial Markets: - Derivatives Core module
Financial Markets & Services by Gordon & Natarajan
Reports:
Report of the RBI-SEBI standard technical committee on exchange
traded Currency Futures
Regulatory Framework for Financial Derivatives in India by
Dr.L.C.GUPTA
Websites visited:
www.nse-india.com
www.bseindia.com
www.sebi.gov.in
132
www.ncdex.com
www.google.com
www.derivativesindia.com
133
ABBREVATIONS
A
AMEX- America Stock Exchange
B
BSE- Bombay Stock Exchange
BSI- British Standard Institute
C
CBOE - Chicago Board options Exchange
CBOT - Chicago Board of Trade
CEBB - Chicago Egg and Butter Board
CME - Chicago Mercantile Exchange
CNX- Crisil Nse 50 Index
CPE - Chicago Produce Exchange
CWC- Central Warehousing Corporation
D
DTSS- Derivative Trading Settlement System
F
FIIs- Foreign Institutional Investors
F & O Future and Options
FMC- Forward Markets Commission
134
135
N
NAFED-National Agricultural Co-Operative Marketing Federation Of India
NCDEX National Commodities and Derivatives Exchange
NIAM- National Institute Of Agricultural Marketing
NMSE- National Multi Commodity Exchange
NOL- Neptune Overseas Limited
NSCCL- National Securities Clearing Corporation
NSDL- National Securities Depositories Limited
NSE - National Stock Exchange
O
OTC- Over The Counter
P
PHLX - Philadelphia Stock Exchange
PNB- Punjab National Bank
R
RBI- Reserve Bank Of India
S
SC(R) A - Securities Contracts (Regulation) Act, 1956
SEBI- Securities Exchange Board Of India
SGX- Singapore Stock Exchange
136
137