INDEX

CHAPTERS PAGE NO
1. Introduction 1-6
Introduction to Derivatives 2
Objectives of the Study 4
Scope of the Study 5
Research Methodology 6
2. Review of Literature 7-56
Derivatives 8-21
Futures 22-36
Options 37-56
3. Company Profile 57-65
3. Analysis 66-75
5. Conclusion 76-77
6. Suggestion 78-79
7. Recommendations 80
8. Bibliography 81

1
INTRODUCTION

2
 INTRODUCTION TO DERIVATIVES

A derivative security is a security whose value depends on the value of together

more basic underlying variable. These are also known as contingent claims. Derivatives

securities have been very successful in innovation in capital markets.

The emergence of the market for derivative products most notably forwards,

futures and options can be traced back to the willingness of risk -adverse economic

agents to guard themselves against uncertainties arising out of fluctuations in asset prices.

By their very nature, financial markets are market by a very high degree of volatility.

Though the use of derivative products, it is possible to partially or fully transfer price

risks by locking – in asset prices. As instrument of risk management these generally don’t

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

investor. Derivatives are risk management instruments which derives their value from an

underlying asset. Underlying asset can be Bullion, Index, Share, Currency, Bonds,

Interest, etc.

3
 OBJECTIVES OF THE STUDY

• To understand the concept and importance of the Financial Derivatives such as

Futures and Options.

• To study the evaluation of the market for derivative products in India.

• To examine the advantages and disadvantages of different strategies along with

situations.

• To understand the properly calculated and well understood risks in pursuit of

reward.

• To understand the principles that governs the pricing of financial derivatives for

successful risk management with derivatives.

• To understand the regulatory framework involved in derivatives trading.

• To study the different ways of buying and selling of Options.

4
 SCOPE OF THE STUDY

The study is limited to “Derivatives” With special reference to Futures and

Options in the Indian context and the Arihant Capital Market has been taken as

representative sample for the study.

The study cannot be said as totally perfect, any alteration may come. The study

has only made humble attempt at evaluating Derivatives Markets only in Indian Context.

The study is not based on the International perspective of the Derivatives Markets.

5
 Research Methodology

The type of research adopted is descriptive in nature and the data collected for this study

is the secondary data i.e. from Newspapers, Magazines and Internet.

Limitations:

 The study was conducted in Hyderabad only.

 As the time was limited, study was confined to conceptual understanding of

Derivatives market in India.

6
REVIEW OF LITERATURE

7
 DERIVATIVES

The emergence of the market for derivative products, most notably forwards,

futures and options, can be traced back to the willingness of risk-averse economic agents

to guard themselves against uncertainties arising out of fluctuations in asset prices. By

their very nature, the financial markets are marked by a very high degree of volatility.

Through of derivatives of 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 underlying prices. However, by locking –in asset prices,

derivatives products minimize the impact of fluctuations in asset prices on the

profitability and cash flow situation of risk–averse investors.

History of Derivatives:
The Derivatives market has existed from centuries as need for both users and producers of
natural resources to hedge against price fluctuations in underlying commodities. Although trading in
agriculture and other commodities has been the driving force behind the development of Derivatives
market in India, the demand for products based on financial instruments – such as bond, currencies,
stocks and stock indices had outstripped the commodities markets.
India has been trading in derivatives market in Silver, spices, gold, coffee, cotton and in oil
markets for decades gray market. Trading in derivatives market was legal before Morarji Desai’s
Government had banned forward contracts. Derivatives on stocks were traded in the form of Teji and
mandi in unorganized markets. Recently futures contracts various commodities were allowed to be on
various exchanges. For Example Cotton and Oil futures were traded in Mumbai, Soya bean futures in
Bhopal, Pepper futures in Kochi, Coffee futures in Bangalore etc.

8
 In June 2000, National stock exchange and Bombay stock exchange started trading in futures in
Sensex and Nifty. Options trading on Sensex and Nifty commenced in June 2001. Very soon thereafter
trading began on futures and options on 31 prominent stocks in the month of July and November
respectively, currently there are 41 stocks trading in NSE derivatives and the list keeps growing.
Derivatives products initially emerged has 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 the in stability in
the financial markets.
Financial derivatives are instruments that their value from financial assets. These assets can be
stocks, bonds, currency etc. These Derivatives can be Forward rate agreements, Futures, Options, and
Swaps. As stated earlier the most traded instruments are futures and options. However these products
became very popular and by 1990s, they accounted for about two-thirds of total transactions in
derivatives 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 class of equity
derivatives, futures and options on stock indices have gained more popularity than on individual stocks,
especially among the institutional investors, who are major users of index-linked derivatives. Even small
investors find these useful due to high correlation of popular indices with various portfolios and ease of
use.

The following factors have been driving the growth of financial derivatives:

 Increased volatility in asset prices in financial markets.

 Increased integration of national financial markets with the international markets.
 Marked improvement in communication facilities and sharp decline in their costs.
 Development of more sophisticated risk management tools, providing economic agents a
wider choice of risk management strategies, and
 Innovations in the derivatives markets, which optimally combine the risks and returns
over a large number of financial assets, leading to higher returns, reduced risks as well as
transactions costs as compared to individual financial assets

9
Definition:

Understanding the word itself, Derivatives is a key to mastery of the topic. The

word originates in mathematics and refers to a variable, which has been derived from

another variable. For example, a measure of weight in pound could be derived from a

measure of weight in kilograms by multiplying by two. In financial sense, these are

contracts that derive their value from some underlying asset. Without the underlying

product and market it would have no independent existence. Underlying asset can a

Stock, Bond, Currency, Index or a Commodity. Some one may take an interest in the

derivative products. Without having an interest in the underlying product market, but the

two are always related and may therefore interact with each other.

The term Derivative has been defined in Securities Contracts (Regulation) Act

1956, as:

A. A security derived from a debt instrument, share, loan

whether secure or unsecured, risk instrument or contract for differences

or any other form of security.

B. A contract, which derives its value from the prices, or index

of prices, of underlying securities.

Importance of Derivatives:

10
 Derivatives are becoming increasingly important in world markets as a tool for

risk management. Derivatives instruments can be used to minimize risk. Derivatives are

used to separate risks and transfer them to parties willing to bear these risks. The kind of

hedging that can be obtained by using derivatives is cheaper and more convenient than

what could be obtained by using cash instruments. It is so because, when we use

derivatives for hedging, actual delivery of the underlying asset is not at all essential for

settlement purposes. More over, derivatives would not create any risk. They simply

manipulate the risks and transfer to those who are willing to bear these risks. For

example, Mr. A owns a bike. If does not take insurance, he runs a big risk. Suppose he

buys insurance [a derivative instrument on the bike] he reduces his risk. Thus, having an

insurance policy reduces the risk of owing a bike. Similarly, hedging through derivatives

reduces the risk of owing a specified asset, which may be a share, currency, etc.

Rationale behind the development of Derivatives:

Holding portfolio of securities is associated with the risk of the possibility that the

investor may realize his returns, which would be much lesser than what he expected to

get. There are various influences, which affect the returns.

1. Price or dividend (interest).

2. Sum are internal to the firm bike:

 Industry policy

 Management capabilities

 Consumer’s preference

11
  Labor strike, etc.

These forces are to a large extent controllable and are termed as “Non-systematic

Risks”. An investor can easily manage such non- systematic risks by having a well-

diversified portfolio spread across the companies, industries and groups so that a loss in

one may easily be compensated with a gain in other.

There are other types of influences, which are external to the firm, cannot be

controlled, and they are termed as “systematic risks”. Those are

1. Economic

2. Political

3. Sociological changes are sources of Systematic Risk.

For instance inflation interest rate etc. Their effect is to cause the prices of nearly all

individual stocks to move together in the same manner. We therefore quite often find

stock prices falling from time to time in spite of company’s earnings rising and vice –

versa. Rational behind the development of derivatives market is to manage this

systematic risk, liquidity. Liquidity means, being able to buy & sell relatively large

amounts quickly without substantial price concessions. In debt market, a much larger

portion of the total risk of securities is systematic. Debt instruments are also finite life

securities with limited marketability due to their small size relative to many common

stocks. These factors favor for the purpose of both portfolio hedging and speculation.

India has vibrant securities market with strong retail participation that has evolved over

the years. It was until recently a cash market with facility to carry forward positions in

12
actively traded “A” group scripts from one settlement to another by paying the required

margins and barrowing money and securities in a separate carry forward sessions held for

this purpose. However, a need was felt to introduce financial products like other financial

markets in the world.

Risks involved in Derivatives:

Derivatives are used to separate risks from traditional instruments and transfer these

risks to parties willing to bear these risks. The fundamental risks involved in derivative

business includes

A. Credit Risk: This is the risk of failure of a counterpart to perform its obligation

as per the contract. Also known as default or counterpart risk, it differs with

different instruments.

B. Market Risk: Market risk is a risk of financial loss as result of adverse

movements of prices of the underlying asset/instrument.

C. Liquidity Risk: The inability of a firm to arrange a transaction at prevailing

market prices is termed as liquidity risk. A firm faces two types of liquidity risks:

 Related to liquidity of separate products.

 Related to the funding of activities of the firm including derivatives.

D. Legal Risk: Derivatives cut across judicial boundaries, therefore the legal aspects

associated with the deal should be looked into carefully.

Characteristics of Derivatives:

13
 1. Their value is derived from an underlying instrument such as stock index,

currency, etc.

2. They are vehicles for transferring risk.

3. They are leveraged instruments.

Types of Derivatives:

Most commonly used derivative contracts are:

Forwards: A forward contract is a customized contract between two entities where

settlement takes place on a specific date in the futures at today’s pre-agreed price.

Forward contracts offer tremendous flexibility to

the party’s to design the contract in terms of the price, quantity, quality, delivery, time

and place. Liquidity and default risk are very high.

Futures: A futures contract is an agreement between two parties to buy or sell an

asset at a certain time in the future at a certain price. Futures contracts are special types of

forward contracts in the sense, that the former are standardized exchange traded

contracts.

Options: Options are 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.

14
Warrants: Longer – dated options are called warrants and are generally traded over –
the – counter. Options generally have lives up to one year, the majority of options traded

on options exchanges having a maximum maturity of nine months.

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 pre-arranged formula. They can be regarded as portfolios of

forward contracts. The two commonly used swaps are: -

Interest rare swaps: These entail swapping only the interest related cash flows
between the parties in the same currency.

Currency swaps: These entail swapping both the principal and interest between
the parties, with the cash flows in one direction being in a different currency than those in

opposite directions.

MAJOR PLAYERS IN DERIVATIVE MARKET:

There are three major players in their derivatives trading.

15
 1. Hedgers.

2. Speculators.

3. Arbitrageurs.

Hedgers: The party, which manages the risk, is known as “Hedger”. Hedgers seek to
protect themselves against price changes in a commodity in which they have an interest.

Speculators: They are traders with a view and objective of making profits. They are
willing to take risks and they bet upon whether the markets would go up or come down.

Arbitrageurs: Risk less profit making is the prime goal of arbitrageurs. They could
be making money even with out putting their own money in, and such opportunities often

come up in the market but last for very short time frames. They are specialized in making

purchases and sales in different markets at the same time and profits by the difference in

prices between the two centers.

DERIVATIVES IN INDIA:

Indian capital markets hope derivatives will boost the nation’s economic

prospects. Fifty years ago, around the time India became independent men in Mumbai

gambled on the price of cotton in New York. They bet on the last one or two digits of the

closing price on the New York cotton exchange. If they guessed the last number, they got

Rs.7/- for every Rupee layout. If they matched the last two digits they got Rs.72/-

Gamblers preferred using the New York cotton price because the cotton market at home

was less liquid and could easily be manipulated. Now, India is about to acquire own

16
market for risk. The country, emerging from a long history of stock market and foreign

exchange controls, is one of the last major economies in Asia, to refashion its capital

market to attract western investment. A hybrid over the counter derivatives market is

expected to develop along side. Over the last couple of years the National Stock

Exchange has pushed derivatives trading, by using fully automated screen based

exchange, which was established by India's leading institutional investors in 1994 in the

wake of numerous financial & stock market scandals.

Derivatives Segments in NSE & BSE:

On June 9, 2000 BSE and NSE became the first exchanges in India to introduce

trading in exchange traded derivative products, with the launch index Futures on Sensex

and Nifty futures respectively. Index Options was launched in june2001, stock options in

July 2001, and stock futures in November 2001.

NIFTY is the underlying asset of the index futures at the futures and options

segment of NSE with a market lot of 50 and Sensex is the underlying stock index in BSE

with a market lot of 30. This difference of market lot arises due to a minimum

specification of a contract value of Rs.2Lakhs by Securities and Exchange Board of

India. For example Sensex is 18000 then the contract value of a futures index having

Sensex as underlying asset will 30x18000 = 540000. Similarly, If Nifty is 5200 its

futures contract value will be 50x5200=260000. Every transaction shall be in multiples of

market lot. Thus, index futures at NSE shall be traded in multiples of 50 and a BSE in

multiples of 30.

17
Contract Periods:

At any point of time there will be always be available nearly 3months contract periods in

Indian Markets.

These were

1) Near Month

2) Next Month

3) Far Month

For example in the month of September 2007 one can enter into September futures

contract or October futures contract or November futures contract. The last Thursday of

the month specified in the contract shall be the final settlement date for the contract at

both NSE as well as BSE, It is also know as Expiry Date.

Settlement:

The settlement of all derivative contracts is in cash mode. There is daily as well as

final settlement. Out standing positions of a contract can remain open till the last

Thursday of that month. As long as the position is open, the same will be marked to

market at the daily settlement price, the difference will be credited or debited accordingly

and the position shall be brought forward to the next day at the daily settlement price.

Any position which remains open at the end of the final settlement day (i.e. last

Thursday) shall closed out by the exchanged at the final settlement price which will be

the closing spot value of the underlying asset.

18
Margins:

There are two types of margins collected on the open position, viz., initial margin

which is collected upfront which is named as “SPAN MARGIN” and mark to market

margin, which is to be paid on next day. As per SEBI guidelines it is mandatory for

clients to give margins, fail in which the outstanding positions or required to be closed

out.

Members of F&O segment:

There are three types of members in the futures and options segment. They are

trading members, trading cum clearing member and professional clearing members.

Trading members are the members of the derivatives segment and carrying on the

transactions on the respective exchange. The clearing members are the members of the

clearing corporation who deal with payments of margin as well as final settlements. The

professional clearing member is a clearing member who is not a trading member.

Typically, banks and custodians become professional clearing members. It is mandatory

for every member of the derivatives segment to have approved users who passed SEBI

approved derivatives certification test, to spread awareness among investors.

Exposure limit:

The national value of gross open positions at any point in time for index futures

and short index option contract shall not exceed 33.33 times the liquid net worth of a

clearing member. In case of futures and options contract on stocks the notional value of

19
futures contracts and short option position any time shall not exceed 20 times the liquid

net worth of the member. Therefore, 3 percent notional value of gross open position in

index futures and short index options contracts, and 5 percent of notional value of futures

and short option position in stocks is additionally adjusted from the liquid net worth of a

clearing member on a real time basis.

Position limit:

It refers to the maximum no of derivatives contracts on the same underlying

security that one can hold or control. Position limits are imposed with a view to detect

concentration of position and market manipulation. The position limits are applicable on

the cumulative combined position in all the derivatives contracts on the same underlying

at an exchange. Position limits are imposed at the customer level, clearing member level

and market levels are different

Regulatory Framework:

Considering the constraints in infrastructure facilities the existing stock exchanges

are permitted to trade derivatives subject to the following conditions.

• Trading should take place through an online screen based trading system.

• An independent clearing corporation should do the clearing of the

derivative market.

20
• The exchange must have an online surveillance capability, which monitors

positions, price and volumes in real time so as to detect market

manipulations. Position limits be used for improving market quality.

• Information about traded quantities and quotes should be disseminated by

the exchange in the real time over at least two information-vending

networks, which are accessible to the investors in the country.

• The exchange should have at least 50 members to start derivatives trading.

• The derivatives trading should be done in a separate segment with a

separate membership. The members of an existing segment of the

exchange will not automatically become the members of derivatives

segment.

21
FUTURES

22
FUTURES

The future contract is an agreement between two parties two buy or sell an asset

at a certain specified time in future for certain specified price. In this, it is similar to a

forward contract. A futures contract is a more organized form of a forward contract; these

are traded on organized exchanges. However, there are a no of differences between

forwards and futures. These relate to the contractual futures, the way the markets are

organized, profiles of gains and losses, kind of participants in the markets and the ways

they use the two instruments. Futures contracts in physical commodities such as wheat,

cotton, gold, silver, cattle, etc. have existed for a long time. Futures in financial assets,

currencies, and interest bearing instruments like treasury bills and bonds and other

innovations like futures contracts in stock indexes are relatively new developments. The

futures market described as continuous auction markets and exchanges providing the

latest information about supply and demand with respect to individual commodities,

financial instruments and currencies, etc. Futures exchanges are where buyers and sellers

of an expanding list of commodities; financial instruments and currencies come together

to trade. Trading has also been initiated in options on futures contracts. Thus, option

buyers participate in futures markets with different risk. The option buyer knows the

exact risk, which is unknown to the futures trader.

Features of Futures Contracts:

The principal features of the contract are as fallows.

23
Organized Exchanges: Unlike forward contracts which are traded in an over- the-

counter market, futures are traded on organized exchanges with a designated physical

location where trading takes place. This provides a ready, liquid market which futures

can be bought and sold at any time like in a stock market.

Standardization: In the case of forward contracts the amount of commodities to be

delivered and the maturity date are negotiated between the buyer and seller and can be

tailor made to buyer’s requirement. In a futures contract both these are standardized by

the exchange on which the contract is traded.

Clearing House: The exchange acts a clearinghouse to all contracts struck on the trading

floor. For instance a contract is struck between capital A and B. upon entering into the

records of the exchange, this is immediately replaced by two contracts, one between A

and the clearing house and another between B and the clearing house. In other words the

exchange interposes itself in every contract and deal, where it is a buyer to seller, and

seller to buyer. The advantage of this is that A and B do not have to under take any

exercise to investigate each other’s credit worthiness. It also guarantees financial integrity

of the market. The enforces the delivery for the delivery of contracts held for until

maturity and protects itself from default risk by mposing margin requirements on traders

and enforcing this through a system called marking – to – market.

Actual delivery is rare: In most of the forward contracts, the commodity is actually

delivered by the seller and is accepted by the buyer. Forward contracts are entered into

for acquiring or disposing of a commodity in the future for a gain at a price known today.

In contrast to this, in most futures markets, actual delivery takes place in less than one

24
percent of the contracts traded. Futures are used as a device to hedge against price risk

and as a way of betting against price movements rather than a means of physical

acquisition of the underlying asset. To achieve, this most of the contracts entered into are

nullified by the matching contract in the opposite direction before maturity of the first.

Margins: In order to avoid unhealthy competition among clearing members in reducing

margins to attract customers, a mandatory minimum margins are obtained by the

members from the customers. Such a stop insures the market against serious liquidity

crises arising out of possible defaults by the clearing members. The members collect

margins from their clients has may be stipulated by the stock exchanges from time to

time and pass the margins to the clearing house on the net basis i.e. at a stipulated

percentage of the net purchase and sale position.

The stock exchange imposes margins as fallows:

1. Initial margins on both the buyer as well as the seller.

2. The accounts of buyer and seller are marked to the market daily.

The concept of margin here is same as that of any other trade, i.e. to introduce a

financial stake of the client, to ensure performance of the contract and to cover day to day

adverse fluctuations in the prices of the securities.

The margin for future contracts has two components:

• Initial margin

• Marking to market

25
Initial margin: In futures contract both the buyer and seller are required to perform the

contract. Accordingly, both the buyers and the sellers are required to put in the initial

margins. The initial margin is also known as the “performance margin” and usually 5% to

15% of the purchase price of the contract. The margin is set by the stock exchange

keeping in view the volume of business and size of transactions as well as operative risks

of the market in general. The concept being used by NSE to compute initial margin on

the futures transactions is called “value- at –Risk” (VAR) where as the options market

had SPAN based margin system”.

Marking to Market:

Marking to market means, debiting or crediting the client’s equity accounts with the

losses/profits of the day, based on which margins are sought. It is important to note that

through marking to market process, die clearinghouse substitutes each existing futures

contract with a new contract that has the settle price or the base price. Base price shall be

the previous day’s closing Nifty value. Settle price is the purchase price in the new

contract for the next trading day.

Futures Terminology:

Spot price: The price at which an asset trades in spot market.

Futures price: The price at which the futures contract trades in the futures market.

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.

26
Contract Size: The amount of asset that has to be delivered under one contract. For

instance contract size on NSE futures market is 100 Nifties.

Basis/Spread:

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

formal market, basis will be positive. This reflects that futures prices normally exceed

spot prices.

Cost of Carry:

The relationship between futures prices and spot prices can be summarized in

terms of what is known as the cost of carry. This measures the storage cost plus the

interest that is paid to finance the asset less the income earned on the asset.

Multiplier:

It is a pre-determined value, used to arrive at the contract size. It is the price per

index point.

Tick Size: It is the minimum price difference between two quotes of similar nature.

Open Interest:

27
 Total outstanding long/short positions in the market in any specific point of time.

As total long positions for market would be equal to total short positions for calculation

of open Interest, only one side of the contract is counted.

Long position: Outstanding/Unsettled purchase position at any point of time.

Short position: Out standing/unsettled sales position at any time point of time.

Index Futures:

Stock Index futures are most popular financial futures, which have been used to hedge or

manage systematic risk by the investors of the stock market. They are called hedgers,

who own portfolio of securities and are exposed to 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 traded on a regulated futures exchange for a specified price at a

specified time in future. Stock index futures will require lower capital adequacy and

margin requirement as compared to margins on carry forward of individual scrip’s. The

brokerage cost 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 incase of stock index futures as opposed to dealing in individual scripts.

The market is conditioned to think in terms of the index and therefore, would refer 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

28
markets and 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 contracts traded. 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 are 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.

Example:

If NSE NIFTY is at 5800 and each point in the index equals to Rs.50, a contract

struck at this level could work Rs.290000 (5800x50). If at the expiration of the contract,

the NSE NIFTY is at 5900, a cash settlement of Rs.5000 is required (5900-5800) x50)

Stock Futures:

With the purchase of futures on a security, the holder essentially makes a legally

binding promise or obligation to buy the underlying security at same point in the future

(the expiration date of the contract). Security futures do not represent ownership in a

corporation and the holder is therefore not regarded as a shareholder

A futures contract represents a promise to transact at same point in the future. In

this light, a promise to sell security is just as easy to make as a promise to buy security.

29
Selling security futures without previously owing them simply obligates the trader to sell

a certain amount of the underlying security at same point in the future. It can be done just

as easily as buying futures, which obligates the trader to buy a certain amount of the

underlying security at some point in future.

Example:

If the current price of the GMRINFRA share is Rs.170 per share. We believe that

in one month it will touch Rs.200 and we buy GMRINFRA shares. If the price really

increases to Rs.200, we made a profit of Rs.30 i.e. a return of 18%.

If we buy GMRINFRA futures instead, we get the same position as ACC in the

cash market, but we have to pay the margin not the entire amount. In the above example

if the margin is 20%, we would pay only Rs.34 per share initially to enter into the futures

contract. If GMRINFRA share goes up to Rs.200 as expected, we still earn Rs.30 as

profit.

Payoff for Futures contracts:

Futures contracts have linear payoffs. In simple words, it means that the losses

as well as profits for the buyer and the seller of a futures contract are unlimited. These

linear payoffs are fascinating as they can be combined with options and the underlying to

generate various complex payoffs.

30
Payoff for buyer of futures: Long futures

The payoff for a person who buys a futures contract is similar to the payoff for a

person who holds an asset. He has a potentially unlimited upside as well as potentially

unlimited downside.

Take the case of a speculator who buys a two-month Nifty index futures

contract when Nifty stands at 4800. The underlying asset in this case is Nifty portfolio.

When the index moves up, the long futures position starts making profits, and when index

moves down it starts making losses.

Payoff for a buyer of Nifty futures

Profit

4800

0 Nifty

LOSS

31
Payoff for seller of futures: Short futures

The payoff for a person who sells a futures contract is similar to the payoff for a

person who shorts an asset. He has potentially unlimited upside as well as potentially

unlimited downside.

Payoff for a seller of Nifty futures

Profit

4800

0 Nifty

Loss

Take the case of a speculator who sells a two-month Nifty index futures contract when

the Nifty stands at 4800. The underlying asset in this case is the Nifty portfolio. When the

index moves down, the short futures position starts making profits, and when index

moves up, it starts making losses.

PRICING FUTURES

Cost of Carry Model: We use fair value calculation of futures to decide the no

arbitrage limits on the price of the futures contract. This is the basis for the cost-of-carry

model where the price of the contract is defined as fallows.

32
F=S+C

Where F – Futures, S – Spot price and C - Holding cost or Carry cost

This can also be expressed as

F = S (1+r) T

Where r- Cost of financing and T - Time till expiration

Pricing index futures given expected dividend amount:

The pricing of index futures is also based on the cost of carry model where the

carrying cost is the cost of financing the purchase of the portfolio underlying the index,

minus the present value of the dividends obtained from the stocks in the index portfolio.

Example

Nifty futures trade on NSE as one, two and three month contracts. Money can be

barrowed at a rate of 15% per annum. What will be the price of a new two-month futures

contract on Nifty?

1. Let us assume that ACC will be declaring a dividend of Rs.10/- per share after 15

days of purchasing of contract.

2. Current value of Nifty is 1200 and Nifty trade with a multiplier of 200.

3. Since Nifty is traded in multiples of 200 value of the contract is

200x1200=240000

33
 4. If ACC as weight of 7% in Nifty, its value in Nifty is Rs.16800 i.e.

(240000x0.07).

5. If the market price of ACC is Rs.140, then a traded unit of Nifty involves 120

shares of ACC i.e. (16800/140).

6. To calculate the futures price we need to reduce the cost of carry to the extent of

dividend received is Rs.1200 i.e. (120x10). The dividend is received 15 days later

and hence compounded only for the remainder of 45 days. To calculate the futures

price we need to compute the amount of dividend received for unit of Nifty.

Hence, we dividend the compounded figure by 200.

7. Thus futures price F = 1200(1.15) 60/365 – (120x10(1.15) 45/365)/200 = Rs.1221.80.

Pricing index futures given expected dividend yield

If the dividend flow through out the year is generally uniform, i.e. if there are few

historical cases of clustering of dividends in any particular month, it is useful to calculate

the annual dividend yield.

F = S (1+ r-q) T

Where F - Futures price, S - Spot index value, r - Cost of financing, q - Expected

dividend yield and T- Holding period

Example:

34
A two-month futures contract trades on the NSE. The cost of financing is 15% and the

dividend yield on Nifty is 2% annualized. The spot value of Nifty is 1200. What is the

fair value of the futures contract?

Fair value = 1200(1+0.15-0.02) 60/365 = Rs.1224.35

Pricing stock futures

A futures contract on a stock gives its owner the right and the obligation to buy or

sell the stocks. Like, index futures, stock futures are also cash settled: There is no

delivery of the underlying stock.

Pricing stock futures when no dividend is expected

The pricing of stock futures is also based on the cost of carry model, where the

carrying cost is the cost of financing the purchase of the stock, minus the present value of

the dividends obtained from the stock. If no dividends are expected during the life of the

contract, pricing futures on that stock is very simple. It simply involves the multiplying

the spot price by the cost of carry.

Example:

SBI futures trade on NSE as one, two and three month contracts. Money can be barrowed

at 15% per annum. What will be the price of a unit of new two-month futures contract on

SBI if no dividends are expected during the period?

1. Assume that the spot price of SBI is Rs.228.

2. Thus, futures price F = 228(1.15) 60/365 = Rs.223.30.

Pricing stock futures when dividends are expected

35
When dividends are expected during the life of futures contract, pricing involves

reducing the cost of carrying to the extent of the dividends. The net carrying cost is the

cost of financing the purchase of the stock, minus the present value of the dividends

obtained from the stock.

Example:

ACC futures trade on NSE as one, two and three month contracts.

What will be the price of a unit of new two-month futures contract on ACC if dividends

are expected during the period?

1. Let us assume that ACC will be declaring a dividend of Rs.10/- per share after 15

days pf purchasing contract.

2. Assume that the market price of ACC is Rs.140/-

3. To calculate the futures price, we need to reduce the cost of carrying to the extent

of dividend received. The amount of dividend received is Rs.10/-. The dividend is

received 15 days later and hence, compounded only for the remaining 45 days.

4. Thus, the futures price

F = 140 (1.15) 60/365 – 10(1.15) 45/365 = Rs.133.08.

36
OPTIONS

37
OPTIONS

An option is a derivative instrument since its value is derived from the underlying

asset. It is essentially a right, but not an obligation to buy or sell an asset. Options can be

a call option (right to buy) or a put option (right to sell). An option is valuable if and only

if the prices are varying. An option by definition has a fixed period of life, usually three

to six months. An option is a wasting asset in the sense that the value of an option

diminishes has the date of maturity approaches and on the date of maturity it is equal to

zero. An investor in options has four choices before him. Firstly, he can buy a call option

meaning a right to buy an asset after a certain period of time. Secondly, he can buy a put

option meaning a right to sell an asset after a certain period of time. Thirdly, he can write

a call option meaning he can sell the right to buy an asset to another investor. Lastly, he

can write a put option meaning he can sell a right to sell to another investor. Out of the

above four cases in the first two cases the investor has to pay an option premium while in

the last two cases the investors receives an option premium.

Definition:

An option is a derivative i.e. its value is derived from something else. In the case

of the stock option its value is based on the underlying stock (equity). In the case of the

index option, its value is based on the underlying index.

38
Options clearing corporation

The Options Clearing Corporation (OCC) is guarantor of all exchange-traded

options once an option transaction has been completed. Once a seller has written an

option and a buyer has purchased that option, the OCC takes over it. It is the

responsibility of the OCC who over sees the obligations to fulfill the exercises. If I want

to exercise an ACC November 100-call option, I notify my broker. My broker notifies the

OCC, the OCC then randomly selects a brokerage firm, which is short one ACC stock.

That brokerage firm then notifies one of its customers who have written one ACC

November 100 call option and exercises it. The brokerage firm customer can be chosen in

two ways. He can be chosen at random or FIFO basis. Because, OCC has a certain risk

that the seller of the option can’t full the contract, strict margin requirement are imposed

on sellers. This margins requirement act as a performance Bond. It assures that OCC will

get its money.

Options Terminology:

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.

Put option:

A put option gives the holder the right but the not the obligation to sell an asset by

a certain date for a certain price.

39
Option price:

Option price is the price, which the option buyer pays to the option seller. It is

also referred to as the option premium.

Expiration date:

The date specified in the option contract is known as the expiration date, the

exercise date, the straight date or the maturity date.

Strike Price:

The price specified in the option contract is known as the strike price or the

exercise price.

American option:

American options are the options that the can be exercised at the time up to the

expiration date. Most exchange-traded options are American.

European options:

European options are the options that can be exercised only on the expiration date

itself. European options are easier to analyze that the American options and properties of

an American option are frequently deduced from those of its European counter part.

In-the-money option:

40
 An in-the-money option (ITM) is an option that would lead to a positive cash

flow to the holder if it were exercised immediately. A call option in the index is said to be

in the money when the current index stands at higher level that 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 in the money. In the case of a put option, the put is in the money if the index is

below the strike price.

At-the-money option:

An At-the-money option (ATM) is an option that would lead to zero cash flow if

it exercised immediately. An option on the index is at the money when the current index

equals the strike price (I.e. spot price = strike price).

Out-of-the-money option:

An out of the money (OTM) option is an option that would lead to a negative cash

flow if it were exercised immediately. A call option on the index is out of he 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.

Intrinsic value of an option:

It is one of the components of option premium. The intrinsic value of a call is the

amount the option is in the money, if it is in the money. If the call is out of the money, its

intrinsic value is Zero. For example X, take that ABC November-call option. If ABC is

41
trading at 102 and the call option is priced at 2, the intrinsic value is 2. If ABC

November-100 put is trading at 97 the intrinsic value of the put option is 3. If ABC stock

was trading at 99 an ABC November call would have no intrinsic value and conversely if

ABC stock was trading at 101 an ABC November-100 put option would have no intrinsic

value. An option must be in the money to have intrinsic value.

Time value of an option:

The value of an option is the difference between its premium and its intrinsic

value. Both calls and puts time value. An option that is OTM or ATM has only time

value. Usually, the maximum time value exists when the option is ATM. The longer the

time to expiration, the greater is an options time value. At expiration an option should

have no time value.

Characteristics of Options:

The following are the main characteristics of options:

1. Options holders do not receive any dividend or interest.

2. Options only capital gains.

3. Options holder can enjoy a tax advantage.

4. Options holders are traded an O.T.C and in all recognized stock exchanges.

5. Options holders can control their rights on the underlying asset.

6. Options create the possibility of gaining a windfall profit.

7. Options holders can enjoy a much wider risk-return combinations.

8. Options can reduce the total portfolio transaction costs.

42
 9. Options enable with the investors to gain a better return with a limited amount of

investment.

Call Option:

An option that grants the buyer the right to purchase a designed instrument is

called a call option. A call option is contract that gives its owner the right but not the

obligation, to buy a specified asset at specified prices on or before a specified date. An

American call option can be exercised on or before the specified date. But, a European

option can be exercised on the specified date only. The writer of the call option may not

own the shares for which the call is written. If he owns the shares it is a ‘Covered Call’

and if he des not owns the shares it is a ‘Naked call’.

Strategies:

The following are the strategies adopted by the parties of a call option. Assuming

that brokerage, commission, margins, premium, transaction costs and taxes are ignored.

A call option buyer’s profit/loss can be defined as follows:

At all points where spot price < exercise price, here will be loss.

At all points where spot prices > exercise price, there will be profit.

Call Option buyer’s losses are limited and profits are unlimited.

Conversely, the call option writer’s profits/loss will be as follows:

43
At all points where spot prices < exercise price, there will be profit

At all points where spot prices > exercise price, there will be loss

Call Option writer’s profits are limited and losses are unlimited.

Following is the table, which explains in the-money, Out-of-the-money and At-the-

money position for a Call option.

Exercise call option Spot price>Exercise price In-The-Money

Do not exercise Spot price<Exercise price Out-of the-Money
Exercise/Do not exercise Spot price=Exercise price At-The-Money

Example:

The current price of RPL share is Rs.260. Holder expect that price in a three month

period will go up to Rs.300 but, holder do fear that the price may fall down below

Rs.260. To reduce the chance of holder risk and at the same time, to have an opportunity

of making profit, instead of buying the share, the holder can buy a three-month call

option on RPL share at an agreed exercise price of Rs.250.

1. If the price of the share is Rs.300. then holder will exercise the option since he

get a share worth Rs.300. by paying a exercise price of Rs.250. holder will

gain Rs.50. Holder’s call option is In-The-Money at maturity.

2. If the price of the share is Rs.220. then holder will not exercise the option.

Holder will gain nothing. It is Out-of-the-Money at maturity.

Payoff for buyer of call option: Long call

44
 The profit/loss that the buyer makes on the option depends on the spot price of the

underlying. If upon expiration, the spot price exceeds the strike price, he makes a profit.

Higher the spot price more is the profit he makes. If the spot price of the underlying is

less than the strike price, he lets his option un-exercise. His loss in this case is the

premium he paid for buying the option.

Payoff for buyer of call option

Profit

4850

0 Nifty

86.

Loss

The figure shows the profit the profits/losses for the buyer of the three-month Nifty

4850(underlying) call option. As can be seen, as the spot nifty rises, the call option is In-

The-money. If upon expiration Nifty closes above the strike of 4850, the buyer would

exercise his option and profit to the extent of the difference between the Nifty-close and

strike price. However, if Nifty falls below the strike of 4850, he lets the option expire and

his losses are limited to the premium he paid i.e. 86.60.

45
Payoff for writer of call option: Short call

For selling the option, the writer of the option charges premium. Whatever is the

buyer’s profit is the seller’s loss. If upon expiration, the spot price exceeds the strike

price, the buyer will exercise the option on the writer. Hence as the spot price increases

the writer of the option starts making losses. Higher the spot price more is the loss he

makes. If upon expiration the spot price is less than the strike price, the buyer lets his

option un-exercised and the writer gets to keep the premium.

Payoff for writer of call option

Profit

86.60

4850

0 Nifty

Loss

The figure shows the profits/losses for the seller of a three-month Nifty 4850 call option.

If upon expiration Nifty closes above the strike of 4850, the buyer would exercise his

option on the writer would suffer a loss to the extent of the difference between the Nifty-

close and the strike price. This loss that can be incurred by the writer of the option is

46
potentially unlimited. The maximum profit is limited to the extent of up-front option

premium Rs.86.60.

Put option:

An option that gives the seller the right to sell a designated instrument is called

put option. A put option is a contract that gives the owner the right, but not the obligation

to sell a specified number of shares at a specified price on or before a specified date.

An American put option can be exercised on or before the specified date. But, a

European option can be exercised on the specified date only.

The following are the strategies adopted y the parties of a put option.

A put option buyer’s profit/loss can be defined as follows:

At all points where spot price<exercise price, there will be gain.

At all points where spot price>exercise price, there will be loss.

Conversely, the put option writer’s profit/loss will be as follows:

At all points where spot price<exercise price, there will be loss.

At all points where spot price>exercise price, there will be profit.

Following is the table, which explains In-the-money, Out-of-the Money and At-the-

money positions for a Put option.

Exercise put option Spot price<Exercise price In-The-Money

47
Do not Exercise Spot price>Exercise price Out-of-The-Money
Exercise/Do not Exercise Spot price=Exercise price At-The-Money

Example:

The current price of RPL share is Rs.250. Holder by a three month put option at

exercise price of Rs.260. (Holder will Exercise his option only if the market price/ spot

price is less than the exercise price).

If the market/Spot price of the RPL share is Rs.245. then the holder will exercise

the option. Means put option holder will buy the share for Rs.245. In the market and

deliver it to the option writer for Rs.260. the holder will gain Rs.15 from the contract.

Payoff for buyer of put option: Long put.

A put option gives the buyer the right to sell the underlying asset at the strike

price specified in the option. The profit/loss that the buyer makes on the option depends

on the spot price of the underlying. If upon the expiration, the spot price is below the

strike price, he makes a profit. Lower the spot price more is the profit he makes. If the

spot price of the underlying is higher than the strike price, he lets his option expire un-

exercised.

Payoff for buyer of put option

Profit

48
 4850

61.70 Nifty

Loss

The figure shows the profits/losses for the buyer of a three-month Nifty 4850

put option. As can be seen, as the spot Nifty falls, the put option is In-The-Money. If

upon expiration, Nifty closes below the strike of 4850, the buyer would exercise his

option and profit to the extent of the difference between the strike price and Nifty-close.

The profits possible on this option can be as high as the strike price. However, if Nifty

rises above the strike of 1250, he lets the option expire. His losses are limited to the

extent of the premium he paid.

Payoff for writer of put option: Short put

The figure below shows the profit/losses for the seller/writer of a three-month

put option. As the spot Nifty falls, the put option is In-The-Money and the writer starts

making losses. If upon expiration, Nifty closes below the strike of 4850, the buyer would

exercise his option on writer who would suffer losses to the extent of the difference

between the strike price and Nifty-close.

49
 Payoff for writer of put option

Profit

61.70

4850

0 Nifty

Loss

The loss that can be incurred by the writer of the option is to a maximum extent

of strike price. Maximum profit is limited to premium charged by him.

Pricing Options:

Factors determining options value:

Exercise price and Share price:

If the share price is more than the exercise price then the holder of the call

option will get more net payoff, means the value of the call option is more. If the share

price is less then the exercise price then the holder of the put option will get more net

pay-off.

50
Interest Rate:

The present value of the exercise price will depend on the interest rate. The

value of the call option will increase with the rise in interest rates. Since, the present

value of the exercise price will fall. The effect is reversed in the case of a put option. The

buyer of a put option receives exercise price and therefore as the interest increases, the

value of the put option will decrease.

Time to Expiration:

The present value of the exercise price also depends on the time to expiration of

the option. The present value of the exercise price will be less if the time to expiration is

longer and consequently value of the option will be higher. Longer the time to expiration

higher is the possibility of the option to be more in the money.

Volatility:

The volatility part of the pricing model is used to measure fluctuations expected

in the value of the underlying security or period of time. The more volatile the underlying

security, the greater is the price of the option. There are two different kinds of volatility.

They are Historical Volatility and Implied Volatility. Historical volatility

estimates volatility based on past prices. Implied volatility starts with the option price as

a given, and works backward to ascertains the theoretical value of volatility which is

equal to the market price minus any intrinsic value.

51
Black scholes pricing models:

The principle that options can completely eliminate market risk from a stock

portfolio is the basis of Black Scholes pricing model in 1973. Interestingly,

before Black and Scholes came up with their option pricing model, there

was a wide spread belief that the expected growth of the underlying ought

to effect the option price. Black and Scholes demonstrate that this is not

true. The beauty of black and scholes model is that like any good model, it

tells us what is important and what is not. It doesn’t promise to produce the

exact prices that show up in the market, but certainly does a remarkable job

of pricing options within the framework of assumptions of the model.

The following are the assumptions;

1. There are no transaction costs and taxes.

2. The risk from interest rate is constant.

3. The markets are always open and trading is continues.

4. The stock pays no dividend. During the option period the firm should not pay any

dividend.

5. The option must be European option.

6. There are no short selling constraints and investors get full use of short sale

proceeds.

The options price for a call, computed as per the following Black Scholes formula:

VC =PS N (d1) - PX/ (e (RF) (T)) N (d2)

52
The value of Put option as per Black scholes formula:

VP=PX/ (e (RF) (T)) N (-d2)-PS N (-d1)

Where d1= In [PS/PX] +T [RF+ (S.D) 2 / 2] / S.D (sqrt (T))

d2= d1-S.D (sqrt (T)

VC= value of call option

VP= value of put option

PS= current price of the share

PX= exercise of the share

RF= Risk free rate

T= time period remaining to expiration

N (d1) = after calculation of d1, value normal distribution area is to be identified.

N (d2) = after calculation of d2, value normal distribution area is to be identified.

S.D= risk rate of the share

In = Natural log value of ratio of PS and PX

Pricing Index Option:

53
 Under the assumptions of Black Scholes options pricing model, index options

should be valued in the way as ordinary options on common stock. The assumption is that

the investors can purchase the underlying stocks in the exact amount necessary to

replicate the index: i.e. stocks are infinitely divisible and that the index follows a

diffusion process such that the continuously compounded returns distribution of the index

is normally distributed. To use the black scholes formula for index options, we must

however, make adjustments for the dividend payments received on the index stocks. If

the dividend payment is sufficiently smooth, this merely involves the replacing the

current index value S in the model with S/eqT where q is the annual dividend and T is the

time of expiration in years.

Pricing Stock Options:

The Black Scholes options pricing formula that we used to price European calls

and puts, with some adjustments can be used to price American calls and puts & stocks.

Pricing American options becomes a little difficult because, unlike European options,

American options can be exercised any time prior to expiration. When no dividends are

expected during the life of options the options can be valued simply by substituting the

values of the stock price, strike price, stock volatility, risk free rate and time to expiration

in the black scholes formula. However, when dividends are expected during the life of the

options, it is some times optimal to exercise the option just before the underlying stock

goes ex-dividend. Hence, when valuing options on dividend paying stocks we should

consider exercised possibilities in two situations. On-just before the underlying stock

goes Ex-dividend, two – at expiration of the options contract. Therefore, owing an option

54
on a dividend paying stock today is like owing to options one in long maturity option

with a time to maturity from today till the expiration date, and other is a short maturity

with a time to maturity from today till just before the stock goes Ex-dividend.

55
 Difference between the Futures and Options

Futures Options
1. Both the parties are obligated to 1. Only the seller (writer) is
perform. obligated to perform.
2. In futures either party pay 2. In options the buyer pays the
premium. seller a premium.
3. The parties to the futures contract 3. The buyer of an options contract
must perform at the settlement can exercise the option at any time
date only. They are obligated to prior to expiration date.
perform the date.
4. The holder of the contract is 4. The buyer limits the downside
exposed to the entire spectrum of risk to the option premium but
downside risk and had the retain the upside potential.
potential for all the upside return.
5. In futures margins are to be paid. 5. In options premium are to be paid.
They are approximately 15 to But they are less as compare to
20% on the current stock price. margin in futures.

56
 COMPANY

PROFILE

INTRODUCTION

57
Arihant Capital Markets Limited is a leading financial intermediary established in 1994.

Arihant is managed by a team of experienced and qualified professionals across all the

levels of management. The company is promoted by Mr. Ashok Kumar Jain, a Chartered

Accountant having more than 20 years of experience in capital markets . Arihant has

been on a growth path under his able leadership and rich experience. He has been our

guide .Throughout our success path. His values of integrity and transparency have been

inculcated in Over the years Arihant has played a successful role in client's wealth

creation. In the Process Arihant also refined itself, as an investment advisor and is poised

to provide Complete Investment Management Solutions Arihant's values of integrity

and transparency in all its transactions are embedded deep into roots helps it to provide

excellent services, steady growth and complete satisfaction to all its clients. Arihant

strongly believes that success is only the end result of client's growth. Arihant has

followed a consistent growth path and is established as one of the leading broking houses

of the country with the support and confidence of clients, investors, employees and

associate.

Services
Over the period of time Arihant has acquired memberships of National Stock

Exchange (NSE), Bombay Stock Exchange (BSE), National Securities Depositories

Limited (NSDL), Central Depository Services Ltd. (CDSL), National Commodities

Exchange (NCDEX), Multi Commodities Exchange (MCX) and also registered with

SEBI for Portfolio Management Services (PMS).

Over the period of time Arihant has acquired memberships of National Stock Exchange

58
(NSE), Bombay Stock Exchange (BSE), National Securities Depositories Limited

(NSDL), Central Depository Services Ltd. (CDSL), National Commodities Exchange

(NCDEX), Multi Commodities Exchange (MCX) and also registered with SEBI for

Portfolio Management Services (PMS).

VISION

“To be a leader in setting standards for quality, investor satisfaction and to

Enhance the wealth of our investors.”

PHILOSOPHY

Integrity and transparency in all transactions. Providing investment solutions based

on quality and unbiased research. Providing personalized services to all investors,

institutions, business associates. Achieving success through client's growth.

STRENGTHS

59
60
MILE STONES

61
RESOURCES

People...

Arihant has always invested in quality human resources continuously striving to provide

Best services to valued clientele. Arihant's strong pool consists of a team of 200+

Professionals including CAs, CS. MBAs. Engineers. Arihant's professionals are fully

geared towards achieving excellence in the field of equity research, investment advisory,

derivative strategies, efficient execution, customer relationship and back office

Operations.

Infrastructure...

In its efforts to continuously provide value added services Arihant has adopted latest

technology and offers excellent execution and post sales support at all branches. Arihant's

Web enabled back office operations enables clients to have online information about their

transactions. Arihant ensures continuous information flow to clients on their mobile

phones through SMS and on their desktops through email and chat. Arihant uses latest

Software for market analysis in order to ensure continuous information flow to clients.

Arihant also provides trading terminals at client's location through CTCL technology

providing live trading at their own locations.

62
Network...

Arihant has a strong network of 150+ branches/business associates providing services to

a more than 5,0000+ number of active retail clients across the country. Arihant provides

Complete investment solutions to clients offering a gamut of products and services. All

branches are equipped to provide complete advisory to clients for investments in equities,

derivatives, commodities , mutual funds and bonds.

RESEARCH

Fundamental Equity Research

Arihant has a strong team of analysts covering large cap, mid cap & small cap companies

across sectors. Arihant research team is credited with the discovery of a number of multi-

baggers creating immense wealth for investors. Arihant's research reports have clarity,

Accuracy, in-depth coverage and the latest information about companies.

Technical Equity Research

Arihant provides technical analysis on various securities and markets on website as well

as on e-mail to valued clientele. Arihant also provides "On line market commentary" to

make the intra day trading more profitable and for minimizing the risk of investors.

Arihant's analysts' team keeps minute-to-minute track of the market and broadcasts buy

and sell recommendations on the basis of market momentum. Arihant's research team

sends trading and investment call alerts on daily basis on mobile phones. This facility is

available free of cost to all investors, associates and active trade.

63
DERIVATIVES (FUTURES AND OPTIONS)
Arihant offers online derivative trading facilities. Arihant provides support in terms of

recommending trading strategies for derivatives and monitoring of positions of clients.

Arihant has a derivative research team, which keeps working on new trading strategies on

a continuous basis. Arihant team is able to provide clients with the best possible

derivative products in the constantly expanding market.

FUTURES
A Future is financial contract obligating the buyer to purchase an asset (or the seller to

sell an asset), such as a physical commodity or a financial instrument, at a predetermined

future date and price. Futures contracts detail the quality and quantity of the underlying

asset; they are standardized to facilitate trading on a futures exchange. Some futures

contracts may call for physical delivery of the asset, while others are settled in cash. The

futures markets are characterized by the ability to use very high leverage relative to stock

markets.

BOARD OF DIRECTORS

Size and Composition of the Board:

The current policy of your Company is to have an optimum combination of executive and

Non executive directors, with not less than 50 per cent consisting of Non executive

directors to maintain the independence of the Board, and to separate the Board functions

of governance and management. Besides, with an Executive Director as the head of the

Board, half of the Board members are independent directors. This is aptly in conformity

with the provisions of the amendedclause 49. The Board, at present consists of 6members

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and the Board believes that the current sizeis appropriate, based on the Company’s

present circumstances. The composition of the Board and the number of outside

directorships held by each of the

Directors is given in the table below:

Mr. Ashok Kumar Jain Executive 3

Mr. Sunil Kumar Jain Non-Executive 3

Mr. Ashish Maheshwari Non-Executive 1

Mr. Akhilesh Rathi Independent 1

Mr. Pramod Devpura Independent NIL

Mr. Rakesh Jain Independent NIL

.

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ANALYSIS

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 FUTURES

Profit/Loss for a Future contract holder:

Example: On 7th Jan 2008 REL is trading at 2100 and REL January 2007 Contract is

trading @ 2120. We expect the share price to rise significantly and want to make a profit

from the increase.

Lot size of REL is 550

Span Margin for REL Future is 42.93% on the contract value

If an Investor bought 1 REL Future @ 2120 on 7th January 2008 and the closing price of

REL Future on 16th Jan 2008 is 2600. To make profit from this transaction the buyer of

the contract can sell the Future and book profit.

Span Margin Payable for buying REL Contract = 2120x550x42.93%=500563

Capital Invested on this contract is Rs.500563/-

On 16th Jan 2008 REL January Contract is trading @2600, If the investor sold the

contract then he would have gained profit of Rs.264000/-

Profit = (2600-2120) x 550 = Rs.264000/-

On 23rd Jan 2008 REL Jan Future closed @ 1600; if the investor holds the future till date.

His Mark to Market loss is as fallows

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Mark to Market Loss = (1600-2120) x 550 = Rs.286000/-

Investor has to pay/receive the margin with respect to the yesterday’s closing price and to

the today’s closing price.

Mark to Market margin payable/receivable = (Today’s Closing price – Yesterdays

Closing Price) x Lot Size

BASIC OPTION STRATEGIES

Buyer of the Call Option

Market View Bullish

Action Buy a call option

Profit Potential Unlimited

Loss Potential Limited

To make a profit from an expected increase in the price of an underlying share during

option’s life:

Case 1: On 30th Nov 2007, IOC is quoting at Rs.538. and the December Rs.560 (strike

price) Call costs Rs.32 (premium). We expect the share price to rise significantly and

want to make a profit from the increase.

Lot Size of IOC is 600

(i) IOC Dec 2007 CA 560 is trading @ 32 (Buying Out of Money Call Option):

Buy 1 IOC call at Rs.32, Market lot for IOC is 600. So, Net outlay is Rs.19200 (32x600).

If IOC shares go up, we can close the position either by selling the option back to the

market or exercising the right to buy the underlying shares at the exercise price.

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On Expiry (27th Dec 2007) Market Price of IOC is Rs. 713/-
DATE Share price Strike Call CALL OPTION VALUE
(Cash Price Premium
market)
th
30 Nov Rs.538 560 32 Buy 1 Dec 560 Call @ Rs.32
Cost = 19200
27th Dec Rs. 713 560 153 1. Sell 1 Dec contract (expiry)
Net gain Rs.153 (713--
560)*600 = Rs.91800
Analysis Rises by 560 Gain: Option sale = Rs.91800
Rs.175. Premium Paid = Rs.19200.
Return Net Profit = Rs.72600.
32.5%

Possible Outcome of IOC If the Spot price is not @ 713 on Expiry:

Share price Rs.713 Option worth Rs.91800. Closing the

position now will produce a net profit of
Rs.72600
Spot price < 560 Option expires worthless. The loss is
Rs.19200 (premium paid)
Share price >= 592 Net profit = Intrinsic value of (Break
even = 560+32) option i.e. by whatever
amount the share price exceeds Rs.592.

To establish a maximum cost at which to purchase shares at a lesser date if funds are not
available immediately:
(ii) IOC Dec 2007 CA 520 is trading @ 47 (Buying In the Money Call Option):

Buy 1 Dec 2007 IOC 520 call option at Rs.47 for total outlay of Rs.28200 on 30th Nov.

On Expiry 27th Dec 2007 Price of IOC is 713

DATE Share price Strike Call CALL OPTION VALUE
Price Premium

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 (Cash
market)
th
30 Rs.538 520 47 Buy 1 Dec 520 Call @ Rs.47
Nov
Cost = 28200
th
27 Rs. 713 520 193 1. Sell 1 Dec contract (expiry)
Dec
Net gain Rs.193 (713-520)*600
= Rs.115800
Analysi Rises by 520 Gain: Option sale = Rs.115800
s Rs.175. Premium Paid = Rs.28200.
Return 32.5%
Net Profit = Rs.87600.

Possible outcome at Expiry

Share price Rs.713 Option worth Rs.115800. Closing the

position now will produce a net profit of

Rs.87600
Spot price < 520 Option expires worthless. The loss is

Rs.28200 (premium paid)

Share price >= 567 Net profit = Intrinsic value of (Break

even = 520+47) option i.e. by whatever

amount the share price exceeds Rs.567.

Writing a Call Option:

To earn additional income from a static shareholding, over and above any dividend

earnings, in terms of premium received on writing the option (Covered short call).

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Date Share price
Market View Bearish/Neutral
(Cash market) Option market
30th Nov Action: Rs.245Sell call against an existing
Sell shareholding
5 Dec 260 calls @
Profit Potential Limited Rs.15
Loss Potential Limited Income = Rs.75000

(15x5000).
27th Dec Rs.248 Option expires worthless
Analysis No change in shareholding Profit = Rs.75000

(Option Premium

received)

Situation: On 30th Nov GMRINFRA share is trading at Rs.245. An investor holds 5000

shares of GMRINFRA. He does not expect its price to move very much in the next few

months. So, he decides to write a call option against this shareholding.

Action: The Dec 260 call is trading at Rs.15 and investor sells 5 contracts (one contract =

1000 shares). He received an option premium of Rs.75000 and takes on the obligation to

deliver 5000 shares at Rs.260 each if the holder exercises the option

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Possible Outcome at Expiry:

The holder will exercise his option.

Share > Rs.260
The investor as a writer will sell shares

originally purchased for Rs.245 at Rs.275

(260+15).
Share price < 260 The option expires worthless.
Share Price = 260 Option won’t be exercised as there is no

price difference.
Buyer of a Put Option:

Market View Bearish

Action Buy a Put option

Profit Potential Unlimited

Loss Potential Limited

To make profit, from a fall in value of share price:

Situation: Current price of NTPC is @ Rs.280 on 14th Nov 2007. An investor thinks that

NTPC is overvalued and may fall substantially. He therefore decides to buy Put option to

gain exposure to its anticipated fall.

Action: Buy 1 NTPC NOV Rs.270 Put at Rs.10 for a total consideration of Rs.16250.

Share price

(Cash market) Option market

14th Nov Rs.280 Buy 1 NTPC NOV put at

Rs.10.

Total outlay = Rs.16250.

th
29 Nov Rs.235 Sell 1 July contract.

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 Net gain = Rs.56875

[Rs.35(270-235)x1625]
Analysis Fall of share price Rs.45. Option purchase =

Rs.16250

Option sale = Rs.56875.

Net profit = Rs.40625.

Possible Outcome at Expiry If NPTC at diff. prices:

Share price = Rs.235 The put will be trading at Rs.35, which

gives a profit of Rs.25 (35-10)*1625, if

the position is closed out.

Share price is 260
Recover intrinsic value premium.
Share Price is between 260 to 270
Loss of Premium Varies from 1625 to

16250/-
Share Price is > 270
Loss of Premium Paid

Writing a PUT Option:

Market View Bullish/neutral

Action Sell put option

Profit Potential Limited

Loss Potential Unlimited

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To generate earnings on portfolio of shares:

Situation: An investor owns 5500 shares of REL and also has cash holding of around

Rs.10000000. In early April he feels that the share price of REL will either remain

constant or slightly rise.

Action: The investor decides to generate some additional income on his portfolio writes

10 REL Rs.1800 puts at Rs. Thus he received a premium of Rs.220000 (40x5500 shares).

Possible Outcome at Expiry

Share price > (or) = Rs.1800 The investor’s expectation is correct and

the put will expire unexercised.

Profit = Rs.220000 (premium received).

Share price < Rs.1800 The put option will be exercised and the

stock will have to be purchased for

Rs.7700000 (9900000-220000).

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CONCLUSION

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 CONCLUSION

Derivatives have existed and evolved over a long time, with roots in commodities

market. In the recent years advances in financial markets and the technology have made

derivatives easy for the investors.

Derivatives market in India is growing rapidly unlike equity markets. Trading in

derivatives require more than average understanding of finance. Being new to markets

maximum number of investors have not yet understood the full implications of the

trading in derivatives. SEBI should take actions to create awareness in investors about the

derivative market.

Introduction of derivatives implies better risk management. These markets can give

greater depth, stability and liquidity to Indian capital markets. Successful risk

management with derivatives requires a through understanding of principles that govern

the pricing of financial derivatives.

In order to increase the derivatives market in India SEBI should revise some of

their regulation like contract size, participation of FII in the derivative market. Contract

size should be minimized because small investor cannot afford this much of huge

premiums.

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SUGGESTIONS

77
 Suggestions to Investors

1. The investors can minimize risk by investing in derivatives. The use of derivative

equips the investor to face the risk, which is uncertain. Though the use of

derivatives does not completely eliminate the risk, but it certainly lessens the risk.

2. It is advisable to the investor to invest in the derivatives market because of the

greater amount of liquidity offered by the financial derivatives and the lower

transactions costs associated with the trading of financial derivatives.

3. The derivatives products give the investor an option or choice whether to exercise

the contract or not. Options give the choice to the investor to either exercise his

right or not. If an expiry date the investor finds that the underlying asset in the

option contract is traded at a less price in the stock market then, he has the full

liberty to get out of the option contract and go ahead and buy the asset from the

stock market. So in case of high uncertainty the investor can go for

options.However, these instruments act as a powerful instrument for knowledgeable

traders to expose them to the properly calculated and well understood risks in

pursuit of reward i.e. profits.

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 RECOMMENDATION

 The derivative market is newly started in India and it is not known by every
investor, so SEBI has to take steps to create awareness among the investors about the
derivative segment.

 In order to increase the derivatives market in India, SEBI should revise some of
their regulations like contract size, participation of FII in the derivatives market.

 Contract size should be minimized because small investors cannot afford this
much of huge premiums.

 SEBI has to take further steps in the risk management mechanism.

 SEBI has to take measures to use effectively the derivatives segment as a tool of
hedging.

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 Bibliography

Indian financial system - M.Y. Khan

Investment management -V.K. Bhalla

Publications of National Stock Exchange

Websites:

www.nseindia.org

www.bseindia.com

www.arihant.com

www.sebi.gov.in

www.moneycontrol.com

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