A Study on Futures and Potions

A view ON FUTURES AND POTIONS Project submitted in partial fulfillment for the exhibit of the degree of MASTER OF BUSINESS ADMINISTRATION DECLARATION I herewith decl atomic number 18 that this Project Report titled, A show ON THE DERIVATIVES submitted by me to the Department OF BUSINESS ADMINISTRATION, XXXX and is a bonafide work under taken by me and it is not submitted to whatsoever other University or Institution for the award of either degree diploma / certificate or published both cartridge clip before. Name and Address of the StudentSignature of the student Date ACKNOWLEDGEMENTI wishing to express my crinkle varyable deep sense of gratitude and as well as thank my guide XXX, Faculty of pay for his signifi crappert suggestions and help in every aspect to accomplish the parturiency work. His persisting encouragement, everlasting patience and keen lodge in in discussions keep back benefited me to the extent that heapnot be spanned by words. I take my pleasure to agnise XXXX for the facilities provided and constant encouragement. Finally I express bows to every matchless(prenominal)(prenominal) who argon involved with this project. table of contents INTRODUCTION METHODOLOGY 1 FUTURES 2 plectronS ANALYSIS OF THE STUDYSUMMARY AND CONCLUSIONS BIBLIOGRAPHY INTRODUCTION temperament of the problem The turnover of the decline exchanges has been tremendously increasing from last 10 years. The number of trades and the number of investors, who ar participating, dedicate gaind. The investors ar ordaining to narrow their seek, so they be seeking for the seek management tools. Prior to SEBI abolishing the BADLA transcription, the investors had this system as a source of reducing the jeopardize, as it has many problems like no strong al lower-rankinganceing system, unclear ending realize and generating counter political company encounter.In view of this problem SEBI abolished the BADLA system. After the abolition of the BADLA system, the investors atomic number 18 seeking for a hedging system, which could reduce their portfolio pretend. SEBI thought the accounting entry of the deriveds profession, as a for the first magazine step it has repose up a 24 member committal under the chairmanship of Dr. L. C. Gupta to develop the appropriate regulatory poser for differential coefficient affair in India, SEBI accepted the recommendations of the committee on May 11, 1998 and approved the phased introduction of the differential coefficients trading beginning with birth major power earlys.There argon many investors who ar provideing to trade in the derivative plane section, because of its advantages like special disadvantage and unlimited good by paying the runty subventions. IMPORTANCE OF THE STUDY To evaluate the increase/ firing scene of plectron carrier and excerpt source. OBJECTIVES OF THE STUDY ? To analyze the derivatives food mart in India. ? To analyze the operations of nexts and pickaxs. ? To take in out the profit/ acquittance position of the cream writer and plectron toter. ? To study about risk management with the help of derivatives. SCOPE OF THE STUDYThe study is limited to Derivatives with special reference to afterlifes and extracts in the Indian scope and the Hyderabad germinate exchange has been taken as a representative audition for the study. The study cant be said as on the whole perfect. Any alteration may come. The study has only made a humble attempt at evaluating derivatives commercialise only in Indian context. The study is not based on the international perspective of derivatives commercialise places, which exists in NASDAQ, NYSE and so on LIMITATIONS OF THE STUDY The adjacent be the limitations of this study. The scrip chosen for abridgment is STATE BANK OF INDIA and the weight-lift taken is show cc5 ending whiz-month peg down. ? The info collected is completely restricted to the STATE BANK OF INDIA of demo 2005 consequently this analysis cannot be taken as universal. METHODOLOGY The emergence of the securities industry for derivative products, most notably forrards, futures and extracts, can be traced back to the impartingness of risk-averse frugal agents to guard themselves against un au indeedticties arising out of fluctuations in addition wrongs.By their very nature, the pecuniary trades atomic number 18 marked by a very racy degree of volatility. through with(predicate) the use of derivative products, it is possible to partially or fully bump off expense risks by lockingin addition harms. As instruments of risk management, these generally do not influence the fluctuations in the cardinal summation hurts. However, by locking-in plus legal injurys, derivative products minimize the impact of fluctuations in plus monetary observes on the profitability and property rise situation of risk-averse investors. Derivatives ar risk management instruments, which derive t heir value from an underlying addition.The underlying asset can be bullion, tycoon, sh atomic number 18, bonds, currency, interest etc. lodges, securities firms, companies and investors to hedge risks, to gain access to cheaper bullion and to make profit, use derivatives. Derivatives be likely to grow even at a faster charge per unit in future. DEFINITION Derivative is a product whose value is derived from the value of an underlying asset in a peg downual manner. The underlying asset can be up justlyness, forex, commodity or any other asset. Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines derivative to include 1.A security derived from a debt instrument, cargon, gain whether secured or unsecured, risk instrument or contract for differences or any other form of security. 2. A contract which derives its value from the legal injurys, or index of impairments, of underlying securities. PARTICIPANTS The avocation contain broad categories of participants in th e derivatives grocery store. HEDGERS Hedgers face risk associated with the impairment of an asset. They use futures or excerpts markets to reduce or eliminate this risk. SPECULATORS Speculators wish to bet on future movements in the legal injury of an asset.Futures and pickaxs contracts can give them an extra leverage that is, they can increase roughly(prenominal)(prenominal) the possible gains and potential losses in a speculative venture. ARBITRAGEURS Arbitrageurs argon in business to take advantage of a discrepancy among sets in cardinal different markets. If, for example, they see the futures equipment casualty of an asset hold upting out of telephone line with the cash scathe, they leave alone take offsetting positions in the cardinal markets to lock in a profit. FUNCTIONS OF DERIVATIVES MARKET The following are the divers(a) functions that are performed by the derivatives markets.They are ? tolls in an organized derivatives market forge the perception of market participants about the future and lead the legal injurys of underlying to the perceived future level. ? Derivatives market helps to transfer risks from those who become them but may not like them to those who have an appetite for them. ? Derivative trading acts as a catalyst for immature entrepreneurial activity. ? Derivatives markets help increase savings and investment in the pertinacious run. Types of derivatives the following are the various types of derivatives. They are ForwardsA forward contract is a customized contract amid twain entities, where extermination takes bureau on a peculiar(prenominal) sequence in the future at todays pre-agreed expenditure. Futures A futures contract is an agreement between 2 parties to barter for or treat an asset at a certain time in the future at a certain equipment casualty. Options Options are of two types birdsongs and go down to stinghers. gossips give the buyer the right field but not the pact to buy a devot ed quantity of the underlying asset, at a habituated determine on or before a given future date. Puts give the buyer the right, but not the obligation to stag a given quantity of the underlying asset at a given equipment casualty on or before a given date.Warrants Options generally have lives of upto one year the majority of excerptions traded on options exchanges having a maximal maturity of nine months. Longer-dated options are scrubed warrants and are generally traded over-the-counter. LEAPS The acronym LEAPS room Long-Term Equity Anticipation Securities. These are options having a maturity of upto three years. Baskets Basket options are options on portfolios of underlying assets. The underlying asset is unremarkably a moving average of a basket of assets. Equity index options are a form of basket options. SwapsSwaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of f orward contracts. The two commonly apply swaps are Interest measure swaps These entail swapping only the interest think cash flows between the parties in the same currency. _ Currency swaps These entail swapping both principal and interest between the parties, with the cash flows in one manner organism in a different currency than those in the face-to-face Direction. Swaptions Swaptions are options to buy or sell a swap that lead become operative at the expiry of the options.Thus a swaption is an option on a forward swap. 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 factors, which affect the returns 1. expense or dividend (interest). 2. Some are internal to the firm like ? industrial indemnity ? Management capabilities ? Consumers preference ? Labor borrow, etc. These forces a re to a large extent controllable and are termed as non Systematic risks.An investor can easily manage such non-systematic by having a well alter portfolio spread across the companies, industries and groups so that a loss in one may easily be compensated with a gain in other. There are yet other types of influences which are external to the firm, cannot be controlled and affect large number of securities. They are termed as systematic risk. They are 1. Economic 2. Political 3. Sociological changes are sources of systematic risk. For instance, inflation, interest rate, etc. their effect is to cause tolls of nearly all individual neckcloths to move unitedly in the same manner.We at that placefore quite much find stock equipment casualtys falling from time to time in spite of companys earnings rising and vice versa. Rationale behind the development of derivatives market is to manage this systematic risk, liquidity and liquidity in the sense of being able to buy and sell relativ ely large sum essentials quickly without pregnant bell concessions. In debt market, a large position of the check risk of securities is systematic. Debt instruments are also finite life securities with limited marketability due to their small sizing relative to many common stocks.Those factors favour for the purpose of both portfolio hedging and speculation, the introduction of a derivative security that is on well-nigh broader market rather than an individual security. India has vibrant securities market with strong retail participation that has rolled over the years. It was until recently basi makey cash market with a facility to prolong forward positions in actively traded A group scrips from one occlusion to another by paying the phone claim for margins and borrowing some money and securities in a cut off carry forward session held for this purpose.However, a need was felt to introduce financial products like in other financial markets world over which are character ized with high degree of derivative products in India. Derivative products allow the drug user to transfer this harm risk by looking in the asset legal injury there by minimizing the impact of fluctuations in the asset determine on his balance sheet and have assured cash flows. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, shares, bonds, currency etc.DERIVATIVE SEGMENT AT NATIONAL line of credit EXCHANGE The derivatives segment on the exchange commenced with S&P CNX swell Index futures on June 12, 20007. The F&O segment of NSE provides trading facilities for the following derivative segment 1. Index Based Futures 2. Index Based Options 3. somebody Stock Options 4. Individual Stock Futures COMPANY NAME CODE drawing card SIZE ABB Ltd. ABB 200 Associated Cement Co. Ltd. ACC 750 Allahabad bound ALBK 2450 Andhra Bank ANDHRABANK 2 three hundred Arvind Mills Ltd. ARVINDMILL 2150 Ash ok Leyland Ltd ASHOKLEY 9550 Bajaj gondola Ltd. BAJAJAUTO 200 Bank of Baroda BANKBARODA 1400 Bank of India BANKINDIA 1900 Bharat Electronics Ltd. BEL 550 Bharat Forge Co Ltd BHARATFORG 200 Bharti Tele-Ventures Ltd BHARTI 1000 Bharat Heavy Electricals Ltd. BHEL 300 Bharat Petroleum union Ltd. BPCL 550 Cadila Healthcare extra CADILAHC 500 Canara Bank CANBK 1600 Century Textiles Ltd CENTURYTEX 850 Chennai Petroleum Corp Ltd. CHENNPETRO 950 Cipla Ltd. CIPLA 1000 Kochi Refineries Ltd COCHINREFN 1300 Colgate Palmolive (I) Ltd. COLGATE 1050 Dabur India Ltd. DABUR 1800 GAIL (India) Ltd. GAIL 1500 keen Eastern Shipping Co. Ltd. GESHIPPING 1350 Glaxosmithkline Pharma Ltd. GLAXO 300 Grasim Industries Ltd. GRASIM 175 Gujarat Ambuja Cement Ltd. GUJAMBCEM 550 HCL Technologies Ltd. HCLTECH 650 housing Development Finance Corporation Ltd. HDFC 300 HDFC Bank Ltd. HDFCBANK 400 grinder Honda Motors Ltd. HEROHONDA 400 Hindalco Industries Ltd. HINDALC0 150 Hindustan Lev er Ltd. HINDLEVER 2000 Hindustan Petroleum Corporation Ltd. HINDPETRO 650 ICICI Bank Ltd. ICICIBANK 700 Industrial development bank of India Ltd. IDBI 2400 Indian Hotels Co. Ltd. INDHOTEL 350 Indian Rayon And Industries Ltd INDRAYON 500 Infosys Technologies Ltd. INFOSYSTCH 100 Indian Overseas Bank IOB 2950 Indian Oil Corporation Ltd. IOC 600 ITC Ltd. ITC 150 thou Airways (India) Ltd. JETAIRWAYS 200 Jindal Steel & Power Ltd JINDALSTEL 250 Jaiprakash Hydro-Power Ltd. JPHYDRO 6250 Cummins India Ltd KIRLOSKCUM 1900 LIC Housing Finance Ltd LICHSGFIN 850 Mahindra & Mahindra Ltd. M&M 625 Matrix Laboratories Ltd. MATRIXLABS 1250 Mangalore Refinery and Petrochemicals Ltd. MRPL 4450 Mahanagar Telephone Nigam Ltd. MTNL 1600 subject area Aluminium Co. Ltd. NATIONALUM 1150 Neyveli Lignite Corporation Ltd. NEYVELILIG 2950 Nicolas Piramal India Ltd NICOLASPIR 950 National Thermal Power Corporation Ltd. NTPC 3250 Oil & Natural Gas Corp. Ltd. ONGC 300 Oriental Bank of Com merce ORIENTBANK 600 Patni Computer System Ltd PATNI 650 Punjab National Bank PNB 600 Ranbaxy Laboratories Ltd. RANBAXY 200 Reliance Energy Ltd. REL 550 Reliance Capital Ltd RELCAPITAL 1100 Reliance Industries Ltd. faith 600 Satyam Computer function Ltd. SATYAMCOMP 600 State Bank of India SBIN 500 Shipping Corporation of India Ltd. SCI 1600 Siemens Ltd SIEMENS 150 Sterlite Industries (I) Ltd STER 350 Sun Pharmaceuticals India Ltd. SUNPHARMA 450 Syndicate Bank SYNDIBANK 3800 Tata Chemicals Ltd TATACHEM 1350 Tata Consultancy Services Ltd TCS 250 Tata Power Co.Ltd. TATAPOWER 800 Tata Tea Ltd. TATATEA 550 Tata Motors Ltd. TATAMOTORS 825 Tata Iron and Steel Co. Ltd. TISCO 675 Union Bank of India UNIONBANK 2100 UTI Bank Ltd. UTIBANK 900 Vijaya Bank VIJAYABANK 3450 Videsh Sanchar Nigam Ltd VSNL 1050 Wipro Ltd. WIPRO 300 Wockhardt Ltd. WOCKPHARMA 600 REGULATORY FRAMEWORKThe trading of derivatives is governed by the commissariat contained in the SC ( R ) A, the S EBI Act, the and the regulations framed there under the rules and byelaws of stock exchanges. Regulation for Derivative Trading SEBI set up a 24 member committed under Chairmanship of Dr. L. C. Gupta develop the appropriate regulatory modelling for derivative trading in India. The committee submitted its state in March 1998. On May 11, 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of Derivatives trading in India beginning with Stock Index Futures.SEBI also approved he Suggestive bye-laws recommended by the committee for regulation and control of trading and resolving power of Derivatives contracts. The provisions in the SC (R) A govern the trading in the securities. The amendment of the SC (R) A to include DERIVATIVES inside the ambit of Securities in the SC (R ) A made trading in Derivatives possible within the framework of the Act. 1. Any exchange fulfilling the eligibility criteria as prescribed in the L. C. Gupta committee report may apply to SEBI for lot of recognition under Section 4 of the SC (R) A, 1956 to start Derivatives Trading.The derivatives exchange/segment should have a separate governing council and representation of trading / clearing members shall be limited to maximum of 40% of the total members of the governing council. The exchange shall regulate the sales practices of its members and will obtain approval of SEBI before start of Trading in any derivative contract. 2. The exchange shall have minimum 50 members. 3. The members of an existing segment of the exchange will not automati abusey become the members of the derivative segment. The members of the derivative segment need to fulfill the eligibility conditions as lay down by the L.C. Gupta Committee. 4. The clearing and stoppage of derivates trades shall be through a SEBI approved elucidation Corporation / Clearing house. Clearing Corporation / Clearing House complying with the eligibility conditions as lay down By the committee have to apply to SEBI for grant of approval. 5. Derivatives broker/dealers and Clearing members are infallible to seek registration from SEBI. 6. The stripped-down contract value shall not be less than Rs. 2 Lakh. Exchanges should also submit details of the futures contract they purpose to introduce. 7.The trading members are required to have qualified approved user and sales person who have passed a certification programme approved by SEBI. FUTURES DEFINITION A Futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. To facilitate liquidity in the futures contract, the exchange specifies certain standard features of the contract. The standardized items on a futures contract are ? Quantity of the underlying ? Quality of the underlying ? The date and the month of livery ? The units of price quotations and minimum price change ? Locations of settlementTYPES OF FUTURES On the base of operations of the underlying ass et they derive, the futures are divided into two types ? Stock futures The stock futures are the futures that have the underlying asset as the individual securities. The settlement of the stock futures is of cash settlement and the settlement price of the future is the closedown price of the underlying security. ? Index futures Index futures are the futures, which have the underlying asset as an Index. The Index futures are also cash settled. The settlement price of the Index futures shall be the closing value of the underlying index on the expiry date of the contract.Parties in the Futures Contract There are two parties in a future contract, the Buyer and the Seller. The buyer of the futures contract is one who is LONG on the futures contract and the trafficker of the futures contract is one who is gyp on the futures contract. The pay off for the buyer and the seller of the futures contract are as follows. PAYOFF FOR A vendee OF FUTURES pic movement 1 The buyer bought the futu re contract at (F) if the futures price goes to E1 so the buyer gets the profit of (FP). CASE 2 The buyer gets loss when the future price goes less than (F), if the futures price goes to E2 then the buyer gets the loss of (FL).PAYOFF FOR A vender OF FUTURES pic F FUTURES equipment casualty E1, E2 SETTLEMENT bell. CASE 1 The Seller sold the future contract at (f) if the futures price goes to E1 then the Seller gets the profit of (FP). CASE 2 The Seller gets loss when the future price goes greater than (F), if the futures price goes to E2 then the Seller gets the loss of (FL). MARGINS Margins are the deposits, which reduce counter party risk, arise in a futures contract. These margins are collected in read to eliminate the counter party risk. There are three types of margins sign MarginWhenever a futures contract is signed, both buyer and seller are required to post initial margin. Both buyer and seller are required to make security deposits that are intended to guarantee that they will infact be able to fulfill their obligation. These deposits are Initial margins and they are often referred as performance margins. The amount of margin is roughly 5% to 15% of total purchase price of futures contract. Marking to Market Margin The make of adjusting the equity in an investors account in order to reflect the change in the settlement price of futures contract is cognise as MTM Margin.Maintenance margin The investor must keep the futures account equity equal to or greater than certain function of the amount deposited as Initial Margin. If the equity goes less than that percentage of Initial margin, then the investor receives a birdsong for an spare deposit of cash known as Maintenance Margin to shoot the equity up to the Initial margin. Role of Margins The role of margins in the futures contract is explained in the following example. S sold a Satyam February futures contract to B at Rs. 300 the following table shows the effect of margins on the contract. The contract size of Satyam is 1200. The initial margin amount is say Rs. 20000, the maintenance margin is 65% of Initial margin. DAY cost OF SATYAM EFFECT ON BUYER (B) EFFECT ON SELLER (S) REMARKS MTM MTM P/L P/L Bal. in Margin Bal. n Margin 1 Contract is entered and 300. 00 initial margin is deposited. 2 +13,200 -13,200 B got profit and S got 311(price increased) +13,200 loss, S deposited 3 maintenance margin. B got loss and deposited maintenance 4 -28,800 margin. +15,400 +28,800 287 B got profit, S got loss. Contract settled at 305, totally B got +21,600 profit and S got loss. -21,600 305 Pricing the Futures The fair value of the futures contract is derived from a model known as the appeal of Carry model. This model gives the fair value of the futures contract. damage of Carry Model F=S (1+r-q) t Where F Futures Price S Spot price of the Underlying r Co st of financing q Expected Dividend Yield T Holding Period. FUTURES TERMINOLOGY Spot price The price at which an asset trades in the military post market. Futures price The price at which the futures contract trades in the futures market.Contract cycle The period over which a contract trades. The index futures contracts on the NSE have one-month, two-months and three-month expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a impudent contract having a three-month expiry is introduced for trading. Expiry date It is the date stipulate in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Contract sizeThe amount of asset that has to be delivered under one contract. For instance, the contract size on NSEs futures market is 200 Nifties. Basis In the context of financial futures, basis can be defined as the futures price damaging the spot price. There will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally go through 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 electropositive the interest that is gainful to finance the asset less the income earned on the asset. Open InterestTotal outstanding long or miserable positions in the market at any specific time. As total long positions for market would be equal to short positions, for calculation of dependent interest, only one side of the contract is counted. pickaxS DEFINITION Option is a type of contract between two persons where one grants the other the right to buy a specific asset at a specifi c price within a specified time period. Alternatively the contract may grant the other person the right to sell a specific asset at a specific price within a specific time period. In order to have this right, the option buyer has to pay the seller of the option allowance. The assets on which options can be derived are stocks, commodities, indexes etc.If the underlying asset is the financial asset, then the options are financial options like stock options, currency options, index options etc, and if the underlying asset is the non-financial asset the options are non-financial options like commodity options. PROPERTIES OF OPTIONS Options have several unique properties that set them apart from other securities. The following are the properties of options ? Limited Loss ? utmost Leverage Potential ? Limited Life PARTIES IN AN OPTION urge on 1. Buyer of the Option The buyer of an option is one who by paying option premium buys the right but not the obligation to form his option on se ller/writer. . Writer/Seller of the Option The writer of a call/put options is the one who receives the option premium and is there by obligated to sell/buy the asset if the buyer exercises the option on him. . TYPES OF OPTIONS The options are classified into various types on the basis of various variables. The following are the various types of options I) On the basis of the Underlying asset On the basis of the underlying asset the options are divided into two types ? INDEX OPTIONS The Index options have the underlying asset as the index. ? behave OPTIONS A stock option gives the buyer of the option the right to buy/sell stock at a specified price.Stock options are options on the individual stocks, there are currently more(prenominal) than 50 stocks are trading in this segment. II. On the basis of the market movement On the basis of the market movement the options are divided into two types. They are ? CALL OPTION A call options is bought by an investor when he seems that the sto ck price moves upwards. A call option gives the holder of the option the right but not the obligation to buy an asset by a certain date for a certain price. ? PUT OPTION A put option is bought by an investor when he seems that the stock price moves downwards. A put option gives the holder of the option right but not the obligation to sell an asset by a certain date for a certain price. III. On the basis of exercise of OptionOn the basis of the exercising of the option, the options are classified into two categories. ? AMERICAN OPTION American options are options that can be exercised at any time up to the expiration date, most exchange-traded options are American. ? EUROPEAN OPTION European options are options that can be exercised only on the expiration date itself. European options are easier to analyze than American options. PAY-OFF PROFILE FOR BUYER OF A CALL OPTION The pay-off of a buyer options depends on the spot price of the underlying asset. The following graph shows the pa y-off of buyer of a call option S- accept priceOTM Out of the bullion SP -Premium/LossATM At the MoneyE1 Spot price 1 ITM In The Money E2 Spot price 2 SR profit at spot price E1 CASE 1 (Spot price resonate Price) As the spot price (E1) of the underlying asset is more than strike price (S). The buyer gets the profit of (SR), if price increases more than E1 than profit also increase more than SR. CASE 2 (Sport price Strike Price) As the spot price (E2) of the underlying asset is less than strike price (s). The buyer gets loss of (SP), if price goes down less than E2 than also his loss is limited to his premium (SP). PAY OFF PROFILE FOR SELLER OF A CALL OPTIONThe pay-off of seller of the call option depends on the spot price of the underlying asset. The following graph shows the pay-off of seller of a call option pic S-Strike priceITM In the Money SP Premium/profitATM At the Money E1-Spot price 1OTM Out of The Money E2 -Spot price 2 SR-profit at spot price E1 CASE 1 (Spo t price Strike price) As the spot price (E1) of the underlying asset is less than strike price (S). The seller gets the profit of (SP), if the price decreases less than E1 than also profit of the seller does not exceed (SP). CASE 2 (Spot price Strike price) As the spot price (E2) of the underlying asset is more than strike price (S).The seller gets loss of (SR), if price goes more less than E2 than the loss of the seller also increase more than (SR). PAY-OFF PROFILE FOR BUYER OF A PUT OPTION The emergence of buyer of the option depends on the spot price of the underlying asset. The following graph shows the pay off of the buyer of a call option pic S-Strike priceITM-In The Money SP-Premium/profitOTM-Out of The Money E1-Spot price 1ATM-At The Money E2-Spot price 2 SR-profit at spot price E1 CASE 1 (Spot price Strike price) As the spot price (E1) of the underlying asset is less than strike price (S). The buyer gets the profit of (SR), if price decreases less than E1 than the profi t also increases more than (SR). CASE 2 (Spot price Strike price)As the spot price (E2) of the underlying asset is more than strike price (s), the buyer gets loss of (SP), if price goes more than E2 than the loss of the buyer is limited to his premium (SP). PAY-OFF PROFILE FOR SELLER OF A PUT OPTION The pay off of seller of the option depends on the spot price of the underlying asset. The following graph shows the pay-off of seller of a put option pic S-Strike priceITM-In The Money SP-Premium/profitATM-At The Money E1-Spot price 1OTM-Out of The Money E2-Spot price 2 SR-profit at spot price E1 CASE 1 (Spot price Strike price) As the spot price (E1) of the underlying asset is less than strike price (S), the seller gets the loss of (SR), if price decreases less than E1 than the loss also increases more than (SR). CASE 2 (Spot price Strike price)As the spot price (E2) of the underlying asset is more than strike price (S), the seller gets profit of (SP), if price goes more than E2 tha n the profit of the seller is limited to his premium (SP). FACTORS AFFECTING THE toll OF AN OPTION The following are the various factors that affect the price of an option. They are Stock price The pay-off from a call option is the amount by which the stock price exceeds the strike price. Call options therefore become more in semiprecious as the stock price increases and vice versa. The pay-off from a put option is the amount by which the strike price exceeds the stock price. Put options therefore become more invaluable as the stock price increases and vice versa. Strike priceIn the case of a call, as the strike price increases, the stock price has to make a larger upward move for the option to go in-the money. Therefore, for a call, as the strike price increases, options become less valuable and as strike price decreases, options become more valuable. era to expiration Both Put and Call American options become more valuable as the time to expiration increases. Volatility The vo latility of n a stock price is a measure of uncertain about future stock price movements. As volatility increases, the chance that the stock will do very well or very poor increases. The value of both Calls and Puts therefore increase as volatility increase.Risk-free interest rate The put option prices decline as the risk free rate increases where as the prices of calls always increase as the risk free interest rate increases. Dividends Dividends have the effect of reducing the stock price on the ex dividend date. This has a negative effect on the value of call options and a positive affect on the value of put options. set OPTIONS The Black Scholes formulas for the prices of European Calls and puts on a non-dividend paying stock are CALL OPTION C = SN (D1)-Xe-rtN(D2) PUT OPTION P = Xe-rtN(-D2)-SN (-D2) C VALUE OF CALL OPTION S SPOT PRICE OF STOCK X STRIKE PRICE r ANNUAL riskiness FREE RETURN CONTRACT CYCLE D1 (ln(s/x) +(r+ )/2) t)/ D2 D1- Options Terminology Strike Price The price specified in the options contract is known as the Strike price or Exercise price. Option Premium Option premium is the price paid by the option buyer to the option seller. sledding Date The date specified in the options contract is known as the expiration date. In-The-Money Option An in the money option is an option that would lead to a positive cash inflow to the holder if it is exercised immediately. At-The-Money Option An at the money option is an option that would lead to zero cash flow if it is exercised immediately. Out-Of-The-Money OptionAn out of the money option is an option that would lead to a negative cash flow if it is exercised immediately. Intrinsic Value of an Option The congenital value of an option is ITM, if option is ITM. If the option is OTM, its intrinsic value is ZERO. Time Value of an Option The time value of an option is the difference between its premium and its intrinsic value. DESCRIPTION OF THE METHOD The following are the go involved in the study. 1. Selection of the scrip The scrip selection is done on a random basis and the scrip selected is conviction COMMUNICATIONS. The lot size of the scrip is 500. Profitability position of the option holder and option writer is studied. 2. Data collectionThe selective information of the RELIANCE COMMUNICATIONS has been collected from the The Economic Times and the internet. The data consists of the March contract and the period of data collection is from 30th December 2008 to thirty-first January 2008. 3. Analysis The analysis consists of the tabulation of the data assessing the profitability positions of the option holder and the option writer, representing the data with graphs and making the interpretations using the data. ANALYSIS ANALYSIS The accusing of this analysis is to evaluate the profit/loss position of option holder and option writer. This analysis is based on the sample data, taken RELIANCE COMMUNICATIONS scrip. This analysis considered the March ending contract o f the SBI.The lot size of SBI is 500. The time period in which this analysis is done is from 30/12/2007 To 31/01/2008 Price of SBI in the Cash Market. DATE MARKET PRICE 30-Dec-07 685. 1 31-Dec-07 714. 65 1-Jan-08 695. 6 2-Jan-08 706. 4 3-Jan-08 717. 1 4-Jan-08 713. 45 7-Jan-08 726. 6 8-Jan-08 724. 05 9-Jan-08 720. 85 10-Jan-08 742. 1 11-Jan-08 736. 14-jan-08 734. 1 15-Jan-08 731. 75 16-Jan-08 728 17-Jan-08 726. 2 18-Jan-08 727. 8 21-Jan-08 722. 7 22-Jan-08 693. 25 23-Jan-08 657. 7 24-Jan-08 664. 4 28-Mar-08 665. 6 29-Jan-08 641. 7 30-Jan-08 661. 05 31-Jan-08 654. 8 pic The closing price of SBI at the end of the contract period is 654. 80 and this is considered as settlement price. The following table explains the amount of transaction between option holder and option writer. ? The first towboat explains the trading date. ? The second column explains the market price in cash segment on that date. ? The call column explains the call/put options which are considered. Every call/put has three sub columns. ? The first column consists of the premium value per share of the contracts, second column consists of the volume of the contract, and the third column consists of total premium value paid by the buyer. ? sort out PAYOFF FOR CALL OPTION bearerS AND WRITERS MARKET PRICE CALLS VOLUME (000) PREMIUM (000) PROFIT TO HOLDERNET PROFIT TO NET PROFIT TO (000) HOLDER (000) BUYER (000) 654. 8 640 199. 5 3634. 15 2952. 6 -681. 55 681. 55 654. 8 660 1463 21600. 35 0 -21600. 35 21600. 35 654. 680 2008 51831. 53 0 -51831. 525 51831. 525 654. 8 700 3297 85603. 45 0 -85603. 45 85603. 45 654. 8 720 3796. 5 74881. 93 0 -74881. 925 74881. 925 654. 8 740 2309. 5 30208. 4 0 -30208. 4 30208. 4 OBSERVATIONS AND FINDINGS ? sextet call options are considered with six different strike prices. ? The current market price on the expiry date is Rs. 654. 80 and this is considered as closing settlement price. The premium paid by the option holders whose strike price is cold and greater than the current market price have paid high amounts of premium than those who are near to the current market price. ? The call option holders whose strike price is less than the current market price are said to be In-The-Money. The calls with strike price 640 are said to be In-The-Money, since, if they exercise they will get profits. ? The call option holders whose strike price is less than the current market price are said to be Out-Of-The-Money. The calls with strike price of 660, 680,700,720,740 are said to be Out-Of-The-Money, since, if they exercise, they will get losses. pic FINDINGSThe premium of the options with strike price of 700 and 720 is high, since most of the period of the contract the cash market is moving around 700 mark. pic FINDINGS ? The contracts with strike price 660, 680, 700, 720, 740 get no profit, since their strike price is more than the settlement price. ? The contract with strike price 640 gets the profit . NET PAY OFF OF PUT OPTION HOLDERS AND WRITERS. MARKET PRICE PUTS VOLUME (000) PREMIUM (000) PROFIT TO HOLDER NET PROFIT TO HOLDER NET PROFIT TO WRITER (000) (000) (000) 654. 600 25 47. 625 0 -47. 625 47. 625 654. 8 640 323. 5 993. 5 0 -993. 5 993. 5 654. 8 660 1239. 5 9506. 575 6445. 4 -3061. 175 3061. 175 654. 8 680 1399. 5 21894 35267. 4 13373. 4 -13373. 4 654. 8 700 1858 30871. 28 83981. 6 53110. 325 -53110. 325 654. 720 1468. 5 23727. 83 95746. 2 72018. 375 -72018. 375 OBSERVATIONS AND FINDINGS ? Six put options are considered with six different strike prices. ? The current market price on the expiry date is Rs. 654. 80 and this is considered as the final settlement price. ? The premium paid by the option holders whose strike price is far and greater than the current market price have paid high amount of premium than those who are near to the current market price. The put option holders whose strike price is more than the current market price are sai d to be In-The-Money. The puts with strike price 660,680,700,720 are said to be In-The-Money, since, if they exercise they will get profits. ? The put option holders whose strike price is less than the current market price are said to be Out-Of-The-Money. The puts with strike price of 600,640 are said to be Out-Of-The-Money, since, if they exercise their puts, they will get losses. pic FINDINGS ? The premium of the option with strike price 700 is higher when compared to other strike prices. This is because of the movement of the cash market price of the SBI between 640 and 720. pic FINDINGS The put option holders whose strike price is more than the settlement price are In-The-Money. ? The put options whose strike price is less than the settlement price are Out-Of-The-Money. DATA OF SBI THE FUTURES OF THE JANUARY MONTH DATE FUTURES CLOSING PRICE (Rs. ) CASH CLOSING PRICE (Rs. ) 30-Dec-07 689. 6 685. 1 31-Dec-07 720. 65 714. 65 1-Jan-08 700. 5 695. 6 2-Jan-08 710. 9 706. 4 3- Jan-08 720. 85 717. 1 4-Jan-08 716. 85 713. 45 7-Jan-08 729. 2 726. 6 8-Jan-08 728. 25 724. 05 9-Jan-08 723. 35 720. 5 10-Jan-08 745. 3 742. 1 11-Jan-08 741. 35 736. 9 14-Jan-08 738. 95 734. 1 15-Jan-08 735. 7 731. 75 16-Jan-08 733. 15 728 17-Jan-08 730. 75 726. 2 18-Jan-08 732. 727. 8 21-Jan-08 725. 25 722. 7 22-Jan-08 695 693. 25 23-Jan-08 660. 1 657. 7 24-Jan-08 666. 7 664. 4 28-Jan-08 667. 75 665. 6 29-Jan-08 642. 7 641. 7 30-Jan-08 662. 5 661. 05 31-Jan-08 655. 95 654. 8 pic OBSERVATIONS AND FINDINGS The cash market price of the SBI is moving along with the futures price. ? If the buy price of the futures is less than the settlement price, then the buyer of the futures get profit. ? If the selling price of the futures is less than the settlement price, then the seller incur losses. SUMMARY, CONCLUSIONS AND RECOMMENDATINONS SUMMARY ? Derivatives market is an innovation to cash market. slightly its daily turnover reaches to the equal stage of cash market. Pr esently the usable scrips in futures are 89 and in options segment are 62. ? In cash market the profit/loss of the investor depends on the market price of the underlying asset. The investor may incur large profits or he may incur huge losses. But in derivatives segment the investor enjoys huge profits with limited downside. ? In cash market the investor has to pay the total money, but in derivatives the investor has to pay premiums or margins, which are some percentage of total money. ? Derivatives are mostly used for hedging purpose. ? In derivative segment the profit/loss of the option holder/option writer is purely depended on the fluctuations of the underlying asset. CONCLUSIONS In bullish market the call option writer incurs more losses so the investor is suggested to go for a call option to hold, where as the put option holder suffers in a bullish market, so he is suggested to write a put option. ? In bearish market the call option holder will incur more losses so the invest or is suggested to go for a call option to write, where as the put option writer will get more losses, so he is suggested to hold a put option. ? In the above analysis the market price of State Bank of India is having low volatility, so the call option writers enjoy more profits to holders. RECOMMENDATIONS ? 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 pull ahead steps in the risk management mechanism. ? SEBI has to take measures to use effectively the derivatives segment as a tool of hedging. BIBLIOGRAPHY BIBLIOGRAPHY BOOKS FUTURES AND OPTIONS N. D. VOHRA, B. R . BAGRI DERIVATIVES CORE MODULE WORKBOOK NCFM corporeal FUTURES AND OPTIONS R. MAHAJAN WEBSITES www. nseindia. com www. equitymaster. com www. peninsularonline. com NEWS EDITIONS THE ECONOMIC TIMES BUSINESS LINE