Intern Ship Project.docx

INTERNSHIP PROJECT ON FUNDAMENTAL AND TECHNICAL ANALYSIS ON EQUITY DERIVATIVES A project report submitted in partial fulfilment of the Requirements for the award of the degree of MASTER OF BUSINESS ADMINISTRATION By N.TARUN KUMAR (121723602037) Under the esteemed guidance of Prof P.ARUNA

GITAM INSTITUTE OF MANAGEMENT, GITAM (Deemed to be University) VISAKHAPATNAM

CERTIFICATE

Certified that this is a bonafide record of project work entitled “FUNDAMENTAL AND TECHNICAL ANALYSIS ON EQUITY DDERIVATIVES”, done in partial fulfilment for the award of the degree of “Master of Business Administration”, GITAM Institute of Management, GITAM(Deemed to be University) ,

Visakhapatnam.

P.ARUNA Professor

GITAM Institute of Management GITAM (Deemed to be University)

DECLARATION I hereby declare that the project entitled "“FUNDAMENTAL AND TECHNICAL ANALYSIS ON EQUTIY DERIVATIVES”, done in partial fulfilment for the award of the degree of “Master of Business Administration”, GITAM Institute of Management, GITAM (Deemed to be University) ,

Visakhapatnam.

Signature of the Candidate N.TARUN KUMAR (121723602037)

ACKNOWLEDGEMENT The satisfaction that accompanies the successful completion of any task would be incomplete without mentioning the people who made it possible and whose constant guidance and encouragement crown all the efforts with success. I would like to express my deep sense of gratitude and sincere thanks to Prof P.ARUNA, GITAM Institute of Management for his consistent guidance, supervision and motivation in completing the project. I would also like to show my gratitude to Dr.P.Sheela, Principal, GITAM Institute of Management, GITAM (Deemed to be University) ,Visakhapatnam Finally it is a great pleasure to thank one and all that have helped directly and indirectly throughout the project.

Signature of Candidate N.TARUN KUMAR (121723602037)

INTRODUCTION ABOUT THE COMPANY J wings manifest wealth is a financial services and trading company which is mainly into stock market and forex trading. They provide training services and various financial advisory services as well. J wings is also into health Insurance and investment planning services .The company has vast experience and comprehensive understanding in the field of forex trade and technical analysis. The company offers trading through an online trading platform, under this online trading platform investors are able to trade through various platforms such as web based terminal, mobile based trading as well as app based trading. These online platforms enable the investors to trade in forex market. They update the investors with the market trends and notify them on various fundamental news regarding various currency pairs. Their office is situated at Horamavu, Bangalore, Karnataka

ABOUT THE PROJECT OBJECTIVES. o Understanding the concept of Indian Derivatives market o To learn more about different derivative instruments and it’s functioning from formation of the agreement till settlement with special focus on futures. o To understand and examine the role of leverage and importance of margin account in futures market o To learn about the pay off structure and about the various risks and rewards related to equity derivatives To study the technical analysis and critically examine the working of futures in derivatives market. o To learn more about the candle stick charts and various technical indicators to analyse underlying assets.

the

RESEARCH METHODOLOGY The study was under taken in the trading floor of kotak. The Information regarding the derivatives is collected from both primary as well as secondary sources of data. Primary data

 Watching the online trading live.  Interacting with the operators at the computer terminal’s the clients trading in kotak .  Collecting information from the head of each department and from the staff working in those departments.

Secondary data  Collecting the data from the website of NSE.  Referring the topics in textbooks and journals relating to stock exchange operations.  Collecting information through internet and also from KARVY STOCK BROKING Limited.

2.3 LIMITATIONS o Limited time period of three months o Indian Derivatives is a very wide topic thus its unable to concentrate on all the derivative instruments in this limited time period o Many are not willing to invest in futures as they are highly leveraged products that carries high risk o Mostly investors are not willing/unable to invest large amounts and are risk averse o Technical indicators may not be completely reliable all the time. o People have less knowledge regarding derivatives market

FOREX MARKET Forex market is also known as currency market , where 36 cross pair currencies are traded .The major and mostly traded six currency pairs are AUS/USD,EUR/USD, GBP/USD,JPY/USD, USD/CHF and XAU/USD(GOLD).The mostly traded currencies are dollar 84.9 % , Euro 39.1% and Yen 19 %. One pip movement in currency is equivalent to 10 dollars , in gold one pip movement is equivalent to 100 dollars and for silver its 50 dollars. Trading in forex is between various currency pairs. The first currency in any currency pair is called base currency and the second currency is called the quote currency. The difference in the ask and bid price gives the spread amount , which goes to the broker as commission.

The bid price is actually the price at which the market is prepared to buy a specific currency pair in the forex market .This is the price at which the trader sells the base currency. The ask price is the price at which the market is prepared to sell a currency pair in the forex market .At this price the trader buys the base currency. For example ,if the quote for eur/usd has been given as bid 1.2815 and ask price as 1.2820 usd. Here the trader can buy a euro for 1.2820 and can go for a short at 1.2815.

A standard lot is 100,000 units of the base currency, a mini lot represents 10,000 units ,a micro lot represents 1000 units and a nano lot represents 100 units of the base currency. A pending order allows the trader to set orders that will be activated once the price reaches a level chosen by the trader. The most important four types of pending orders are buy limit,sell limit, sell stop and buy stop. A buy limit order is executed when a buy order is placed below the current market price. A buy stop order is entered at a stop price above the current market price. A sell limit order is a sell pending order that is placed above the market price. A sell stop order is an order to sell a stock if its price falls to a certain predetermined amount .

INDIAN DERIVATIVES INDUSTRIAL PROFILE INTRODUCTION TO FINANCIAL MARKETS Finance is the integral part of modern business. Financial markets refer to the institutional arrangements for dealing in financial assets and credit instruments of different types, such as currency cheques, bank deposits bills, etc. The main functions of the financial markets are: (i) To facilitate creation and allocation of credit and liquidity (ii) To serve as intermediaries for mobilization of savings; (iii) To assist the process of balanced economic growth; (iv) To provide financial convenience; (v) To cater to the various credits needs of the business houses.

Types of Financial markets: On the basis of the maturity period of the financial assets, the market can be divided into: 1. Money market:

A money market is a mechanism through which short-term funds are loaned and borrowed and through which a large part of the financial transaction of a particular country of the world are cleared. The money market is divided into 3 sectors namely organized sector, unorganized sector and Cooperative sector.

a. Organized sector is comparatively well developed in terms of organized relationships and specialization of functions. It consists of the Reserve Bank of India, various scheduled and non-scheduled commercial banks. The development banks, other financial institutions like LIC, UTI, discount and finance house of India limited are all a part of the organized sector.

b. The unorganized sector is more dominate in India. The only link between the organized and unorganized sectors is through commercial banks. It consists of the indigenous bankers, Moneylenders, Nidhis and Chit funds.

c. The cooperative sector consists of the state –cooperative banks, primary agricultural credit societies, Central Cooperative banks, and State Land Development banks. 2. Capital market:

Capital market is an organized mechanism for effective and efficient transfer of money capital of financial resources form the investing class i.e., a body of individual or institutional savers, to the entrepreneur class i.e., a body of individual or institutions engage in industry, business or service in the private and public sectors of the economy.

Functions of capital market: The capital market is directly responsible for the following activities. 

Mobilization of National savings for economic development



Mobilization and import of foreign capital and foreign investment capital plus skill to fill up the deficit in the required financial resources to maintain expected rate of economic growth.



Productive utilization of resources



Direction the flow to funds of high yields and also strives for balance and diversified industrialization.

Constituents of capital market: The capital market comprises of mutual funds, development banks, specialized financial institutions, investment institutions, state level development banks, lease companies, financial service companies, commercial banks and other specialized institutions set up for the growth of capital market like SEBI, CRISIL. Instruments Capital market: The following instruments are being used for raising resources. Equity shares Preference shares Non-voting equity shares Cumulative convertible preference shares company fixed deposits, banks, and debentures, global depository receipts. The capital market is divided into two parts namely new issues market and Stock market.

STOCK EXCHANGES IN INDIA At the end of the June 1989, there were 18 recognized stock exchanges in India. Among the 18 stock exchanges, the first organized stock exchange set up at Bombay in 1857 is distinguished not only by its size but also it has been recognized permanently, while the recognition for other markets is renewed every 5 years. Stock markets are organized either as voluntary, non-profit making associations (Bombay, Ahmadabad, Indore) or public limited companies (Calcutta, Delhi, Bangalore) or company limited by guarantee (Madras, Hyderabad). In India, the growth of stock exchanges has been linked to the growth of

corporate

sector. Though a number of stock exchanges were set up before independence but, there was no All India legislation to regulate they’re working. Every stock exchange followed its own methods of working .To rectify this situation, The SECURITY CONTRACTS (REGULATIONS) ACT was passed in 1956. In 1965, 22 separate provincial stock exchanges were merged into 3 regional stock exchanges and in 1973 these, in turn, were combined to form the National Stock Exchange (NSE) under the title of the stock exchange that has trading floors in many former provincial center. At present, there are 26 stock exchanges in our country. The over-the counter exchange of India began its operations in 1992. Since 1995, trading in securities is screen based (on-line)

BOMBAY STOCK EXCHANGE (BSE): Bombay stock exchange is the first organized stock exchange set up at Bombay in 1857. It is the premier or apex stock exchange in India as it is distinguished not only by its size but also it has been recognized permanently while recognition of other stock exchanges is renewed every 5 years. It is the oldest stock market.

Bombay Stock Exchange raised the threshold limit for listing to Rs.10 crores, moved on to weekly settlement and quicker actions for each settlement. Settlement is through the clearinghouse. 12 days carry forward is allowed on BSE. Index in BSE is ‘SENSEX’. BSE membership fee in 1857 was just Rs1lakh and now it in about Rs 2crores.

NATIONAL STOCK EXCHANGE (NSE)

National Stock Exchange of India Ltd was started in 1992 with a paid-up equity of Rs.25 crores. The government recognized it in the same year and NSE started its operations in wholesale in Nov 1994.

NSE MISSION NSE mission is setting the agenda for change in the securities markets in India.

The NSE was set-up with the main objectives of:

 establishing a nation-wide trading facility for equities, debt instruments

and

hybrids,  ensuring equal access to investors all over the country through an appropriate communication network,  providing a fair, efficient and transparent securities market to investors using electronic trading systems,  enabling shorter settlement cycles and book entry settlements systems, and  meeting the current international standards of securities markets.

NSE LOGO

The logo of the NSE symbolizes a single nationwide securities trading facility ensuring equal and fair access to investors, trading members and issuers all over the country. The initials of the Exchange viz., N, S and E have been etched on the logo and are distinctly visible. The logo symbolizes use of state of the art information technology and satellite connectivity to bring about the change within the securities industry. The logo symbolizes vibrancy and unleashing of creative energy to constantly bring about change through innovation.

NSE

MILE

STONES

April 1993

November 1992

May 1993

Formulation of business plan

June 1994

Wholesale Debt Market segment goes live

November 1994

Capital Market (Equities) segment goes live

March 1995

Establishment of Investor Grievance Cell

April 1995

Establishment of NSCCL, the first Clearing Corporation

June 1995

Introduction of centralized insurance cover for all trading members

July 1995

Establishment of Investor Protection Fund

October 1995

Became largest stock exchange in the country

April 1996

Commencement of clearing and settlement by NSCCL

April 1996

Launch of S&P CNX Nifty

Incorporati

June 1996

November 1996

Establishment of Settlement Guarantee Fund Setting up of National Securities Depository Limited, first depository in India, co-promoted by NSE

November 1996

Best IT Usage award by Computer Society of India

December 1996

Commencement of trading/settlement in dematerialised securities

December 1996

Dataquest award for Top IT User

December 1996

Launch of CNX Nifty Junior

February 1997

Regional clearing facility goes live

November 1997

Best IT Usage award by Computer Society of India

May 1998

Promotion of joint venture, India Index Services & Products Limited (IISL)

May 1998

Launch of NSE Web-site: www.nse.co.in

July 1998

Launch of NSE Certification Programme in Financial Market

August 1998

CYBER CORPORATE OF THE YEAR 1998 award

February 1999

Launch of Automated Lending and Borrowing Mechanism

April 1999

CHIP Web Award by CHIP magazine

October 1999

Setting up of NSE.IT

January 2000

Launch of NSE Research Initiative

February 2000

Commencement of Internet Trading

June 2000

Commencement of Derivatives Trading (Index Futures)

September 2000

Launch of 'Zero Coupon Yield Curve'

November 2000

Launch of Broker Plaza by Dotex International, a joint venture betw

December 2000

Commencement of WAP trading

June 2001

Commencement of trading in Index Options

July 2001

Commencement of trading in Options on Individual Securities

November 2001

Commencement of trading in Futures on Individual Securities

December 2001

Launch of NSE VaR for Government Securities

January 2002

Launch of Exchange Traded Funds (ETFs)

May 2002

NSE wins the Wharton-Infosys Business Transformation Award in t

October 2002

Launch of NSE Government Securities Index

January 2003

Commencement of trading in Retail Debt Market

June 2003

Launch of Interest Rate Futures

August 2003

Launch of Futures & options in CNXIT Index

June 2004

Launch of STP Interoperability

August 2004

Launch of NSE electronic interface for listed companies

March 2005

‘India Innovation Award’ by EMPI Business School, New Delhi

June 2005

Launch of Futures & options in BANK Nifty Index

December 2006

'Derivative Exchange of the Year', by Asia Risk magazine

January 2007

Launch of NSE – CNBC TV 18 media center

March 2007

NSE, CRISIL announce launch of IndiaBondWatch.com

June 2007

NSE launches derivatives on Nifty Junior & CNX 100

October 2007

NSE launches derivatives on Nifty Midcap 50

January 2008

Introduction of Mini Nifty derivative contracts on 1st January 2008

March 2008

Introduction of long term option contracts on S&P CNX Nifty Index

June2008

Launch of NCFM - Derivatives Market (Dealers) Module Test in Hin

September 2008 Launch of FEDAI-NSE Currency Futures (Basic) Module

Jan2009

Launch of Mutual Funds : A Beginners Module

Feb2009

Launch of NCFM - Capital Market (Dealers) Module Test in Gujarat

Feb2009

Launch of Shariah BeEs on Feb 4, 2009

Mar2009 Launch of "Options Trading Strategies Module"

NSE Technology Across the globe, developments in information, communication and network technologies have created paradigm shifts in the securities market operations. Technology

has enabled organizations to build new sources of competitive advantage, bring about innovations in products and services, and to provide for new business opportunities. Stock exchanges all over the world have realised the potential of IT and have moved over to electronic trading systems, which are cheaper, have wider reach and provide a better mechanism for trade and post trade execution.

NSE believes that technology will continue to provide the necessary impetus for the organization to retain its competitive edge and ensure timeliness and satisfaction in customer service. In recognition of the fact that technology will continue to redefine the shape of the securities industry, NSE stresses on innovation and sustained investment in technology to remain ahead of competition. NSE IT set-up is the largest by any company in India. It uses satellite communication technology to energies participation from around 400 cities spread all over the country. In the recent past, capacity enhancement measures were taken up in regard to the trading systems so as to effectively meet the requirements of increased users and associated trading loads. With up gradation of trading hardware, NSE can handle up to 1 million trades per day.

CIRCUIT BREAKERS The Exchange has implemented index-based market-wide circuit breakers in compulsory rolling settlement with effect from July 02, 2001

INDEX-BASED MARKET-WIDE CIRCUIT BREAKERS

The S & P CNX The index-based market-wide circuit breaker system applies at 3 stages of the index movement, either way viz. at 10%, 15% and 20%. These circuit breakers when triggered bring about a coordinated trading halt in all equity and equity derivative

markets nationwide. The market-wide circuit breakers are triggered by movement of either the BSE Sensex or the NSE S&P CNX Nifty, whichever is breached earlier.

 In case of a 10% movement of either of these indices, there would be a one-hour market halt if the movement takes place before 1:00 p.m. In case the movement takes place at or after 1:00 p.m. but before 2:30 p.m. there would be trading halt for ½ hour. In case movement takes place at or after 2:30 p.m. there will be no trading halt at the 10% level and market shall continue trading.

 In case of a 15% movement of either index, there shall be a two-hour halt if the movement takes place before 1 p.m. If the 15% trigger is reached on or after 1:00p.m. but before 2:00 p.m., there shall be a one-hour halt. If the 15% trigger is reached on or after 2:00 p.m. the trading shall halt for remainder of the day.

 In case of a 20% movement of the index, trading shall be halted for the remainder of the day.

S&PCNX NIFTY:

NIFTY is based upon solid economic research it the new world of financial product on the index like index futures, index options and index funds. A trillions calculations were expanded to evolve the rules inside the S&P CNX Nifty index. The result of this work is remarkably simple:

 The correct size is to use is 50.

 Stocks considered for the S&P CNX Nifty must be liquid by the 'Impact criterion.  The largest 50 stocks that meet the criterion go into the index.

The nifty is uniquely equipped as an index for the index market owing to its  Low market impact cost  High edging effectiveness

Derivatives are financial products whose value is determined from one or more underlying assets in a contractual manner. The underlying asset can be commodities or financial assets. Derivative markets are working on the basis of spot price and future price. Derivative market functions according to the agreements between parties to the contract. Major function of Derivative contracts is risk management. The common underlying assets for derivatives are equity shares, equity indices, debt market securities, interest rates, foreign exchange and commodities. The major derivative exchanges in India include the following:

• • • •

Bombay stock exchange(BSE) National Commodity and Derivatives Exchange (NCDEX) National stock exchange(NSE) Multi Commodity Exchange(MCX) Derivative is a contract or a product whose value is derived from value of some other asset known as underlying. Derivatives are based on wide range of underlying assets. These include:

•

Metals such as Gold, Silver, Aluminum, Copper, Zinc, Nickel, Tin, Lead

•

Energy resources such as Oil and Gas, Coal, Electricity

•

Agri commodities such as wheat, Sugar, Coffee, Cotton, Pulses and

•

Financial assets such as Shares, Bonds and Foreign Exchange.

The factors driving the growth of equity derivatives are:

• •

Increased volatility in asset prices in financial markets Increased integration of national financial markets with the international markets

cost

• •

Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies Innovations in the derivatives markets

DERIVATIVES: FINANCIAL WEAPON OF MASS DESTRUCTION 4.1 HISTORY The origin of derivatives can be linked to the need of the farmers to protect their crops against the fluctuations in the price of their crop. Earlier, from the time of sowing to the time of crop harvest, farmers always faces uncertainties regarding the price of the commodity, but with the introduction of derivative products farmers are in a position to hedge their price risk by locking in asset prices. These happens on the basis of certain simple contracts between two parties one can be a farmer and other can be a merchant or any other interested person to the contract. With the help of these agreements the supplier is in a position to earn more when the prices fall down because of high supply during harvest period. The merchant or the second party to the contract also benefits from the derivative contracts. The merchant is assured with the supply of certain commodities on a pre determined date for a predetermined price. This helps him to secure himself from paying more amounts of cash for a certain commodity in case of scarcity or low supply. In this way both the parties to the contract will be benefitted from derivative contracts.

The concept of derivatives can be tied to the formation of Chicago Board of Trade (CBOT) in 1845 by a group of farmers and merchants with an aim to safeguard the interest of participants of the board by predetermining the price of commodities with the help of lock in price. They setup the world’s first commodity exchange under the name of CBOT in the year 1848. The concept became very successful for hedging and speculating the price changes of various commodities traded and in 1925, the first future clearing house came into existence.

Derivatives have been associated with a number of high-profile corporate events that shocked the global financial markets over the past two decades. To some critics, derivatives have played an important role in the near collapses or bankruptcies of Barings Bank in 1995, Long-term Capital Management in 1998, Enron in 2001, Lehman Brothers in and American International Group (AIG) in 2008 sub-prime crisis etc. Warren Buffet even viewed derivatives as time bombs for the economic system and called them financial weapons of mass destruction. But derivatives, if properly handled, can bring substantial economic benefits. These instruments help economic agents to improve their management of market and credit risks. They also foster financial innovation and market developments, increasing the market resilience to shocks. Derivatives can be of two types mainly;

 Financial Derivatives

 Commodity Derivatives

4.2 EXCHANGE TRADED MARKETS This is the market where individuals trade with standardized contracts that has been approved by the exchange. People have been trading in derivatives exchanges since a long time. In 1848 Chicago Board of Trade (CBOT) was established to bring farmers and merchants together. Initially their main duty was to standardize the quantities and qualities of the grains that were traded. Within a very few years the first futures contract was developed and came to be known as the to arrive contract. The speculators found trading in contracts as more attractive than trading in grain itself. In 1919 Chicago Mercantile Exchange(CME) was established followed by various exchanges all over the world. The CBE and CBOT were later emerged to form the CME group, which also includes the New york mercantile exchange ,the commodity exchange (COMEX) , and the Kansas city Board of Trade (KCBT).

The Chicago Board of Options Exchange started trading on call option contracts on 16 stocks in 1973 .Options were even traded prior to 1973 but CBOE could create an orderly market with well defined contracts. Put options started trading on the exchange in 1977. The CBOE now trades options on over 2500 stocks and many different stock indices. Traditionally derivative exchanges have been using the open outcry system, wherein the traders physically meeting on the floor of the exchange, shouting and by using various hand signals to indicate the trades that they would like to place .This open outcry system has been largely replaced by the electronic trading .Wherein the user enters the trade with the help of a computer terminal and places their trade online. Electronic markets makes use of computer programs to initiate trades and has led to a growth in high frequency and algorithm trading.

4.3 OVER -THE COUNTER MARKETS This is not a physical market place but a collection of brokers and dealers, scattered across the country. The main participants in OTC derivative markets are large financial institutions, banks, fund managers and corporations. Once an OTC trade has been agreed, the two parties can either present it to a central counterparty (ccp) or clear the trade bilaterally. A CCP takes up the role of an exchange clearing house, it stands between two parties to the transaction so that one party do not have to bear the risk of default from another party. Usually participants in the OTC market have contacted each other through phone and email or finds a counter party through an interdealer broker . OTC market is less regulated as the trades take place between qualified and capable counterparties , who are supposed to take care of their trades. At the same time exchange traded contracts are highly standardized contracts ,whose prices are determined by the interaction of buyers and sellers on an anonymous auction platform. The clearing house guarantees settlement of transactions. The number of derivatives transactions per year in OTC

market is smaller compared to that in exchange traded markets. But the average size of the transactions in OTC market is much greater.

4.5 FINANCIAL DERIVATIVES Section 2(ac) of securities contract Regulation Act (SCRA) 1956 defines Derivative as “a contract which derives its value from the prices, or index of prices of underlying securities. Financial Derivatives can be defined as financial instruments whose value is based on the performance of assets such as stocks, bonds, currency exchange rates etc. The growing instability in the financial markets helped the financial derivatives in gaining prominence after1970. The growing instability includes the collapse of the Bretton Woods system of fixed exchange rates in 1971 which increased the demand for hedging against exchange rate risk. The Chicago Mercantile Exchange allowed trading in currency futures in the following year. Advancements in options pricing research, most notably the Nobel-prize winning Black-Scholes options pricing model introduced in the year 1997, provided a new framework for portfolio managers to manage risks. In recent years, the market for financial derivatives has grown in terms of the variety of instruments available, as well as their complexity and turnover. Financial derivatives have changed the world of finance through the creation of innovative ways to understand , measure, and manage risk.

Applications Of Financial Derivatives a. Management of risk: Risk management is not the elimination of risk but the management of risk. Financial derivatives provide a powerful tool for limiting risks that individuals and organizations face in the ordinary conduct of their business. It requires a thorough understanding of the basic principles that regulate the pricing of financial derivatives. Proper and effective use of financial derivatives can save cost and can also increase returns. b. Efficiency in trading : Financial derivatives allow for free trading of risk components and that leads to improving market efficiency. Traders can use a position in one or more financial derivatives as a substitute for a position in the underlying instruments.

c. The underlying instruments: In many instances, traders find financial derivatives to be a more attractive instrument than the underlying security. This is mainly because of the greater amount of liquidity in the market offered by derivatives as well as the lower transaction costs associated with trading a financial derivative as compared to the costs of trading the underlying instrument in cash market.

d. Speculation : Financial derivatives are considered to be highly risky .If not used properly these can lead to huge financial destruction. But these are powerful instruments for knowledgeable traders to expose themselves to calculated and well understood risks for high returns.

e. Price Stabilization function : Derivative market helps to keep a stabilizing influence on spot prices by reducing the short-term fluctuations.

4.6 EQUITY DERIVATIVES An equity derivative is a derivative instrument whose value is derived from underlying assets based on equity securities. An equity derivative's value will fluctuate with changes in its underlying asset's equity, which is usually measured by share prices in the spot market. The major types of equity derivatives are forwards, futures and options. A forward contract is a contractual agreement between two parties to buy and sell asset at a certain time in future , at a price decided on the date of the contract .A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Options are contracts that grant the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date. The right to buy is call option and the right to sell is put option.

4.7 COMMODITY DERIVATIVES Derivative contracts where underlying assets are commodities are called as commodity derivatives. These underlying assets can include precious metals (gold, silver, platinum), agro products (coffee, wheat, pepper, cotton), energy products ( crude oil, heating oil, natural gas) etc. They help in future price discovery of underlying commodities. Here the trade is routed through certain organized mechanisms. The major focus is that presently farmers are deciding the commodity to be cultivated for next year is based on the price of the commodity in current year. Ideally this decision should be based on next year’s expected price. This can be obtained with the help of the price discovery mechanism of commodity market.

4.8 PARTICIPANTS IN A DERIVATIVE MARKET The following are the participants in a derivative market; Fig 1

PARTICIPANTS

HEDGERS

SPECULATORS

ARBITRAGERS

 Hedgers Hedgers face the risk associated with price of an asset. They use the futures or options market to reduce or eliminate the risk. Derivative market with the help of various instruments will transfer risk from person who have them but may not like them to those who are ready to take it.

 Speculators Speculators are people who bet on the future movement of the price of an asset. Instruments like futures and options give them more leverage because by keeping a small amount of money upfront, they can take large positions in the market. Because of this leverage they increase the potential for large profits and large gains.

 Arbitragers Arbitragers works on the principle of taking the advantage of variations or discrepancy in prices across markets. They usually take offsetting positions in two different markets to lock in the profits. It happens when a trader purchases an asset cheaply in one location and simultaneously arranges to sell it at a higher price in another location.

4.9 DERIVATIVE INSTRUMENTS  Forwards Forward contracts are agreement between two parties who are agreed to buy/sell the underlying at a future date at today’s predetermined price. Forward contracts are not regulated by exchange and because of that they take place over the counter. There are no formal rules for market stability, integrity and for safeguarding the interest of market participants in these instruments.

 Futures Future contracts are agreements between two parties to buy or sell some underlying assets at a future date at today’s future price. They are exchange regulated and hence over the counter transaction is not allowed. Futures are standardized exchange traded contracts.

 Options There are mainly two types of options;

 Call option: A call option gives the buyer the right not the obligation to buy a given quantity of underlying asset at a given price on or before the due date.

 Put option: A put option gives the seller the right not the obligation to sell a given quantity of underlying asset at a given price on or before the due date.

 Warrants Option contracts generally have a life time of maximum twelve months. Most of the option agreements are for nine months. Option contracts which are traded for more than nine months are called warrants.

 Baskets: Baskets options are options on portfolio of underlying assets. The underlying asset will be the weighted average of the assets in the basket. Equity index options are a form of basket options.

 Swaps: Swaps are agreements between two parties to exchange cash flows in the future according to some prearranged formula. There are mainly two types of swaps namely interest rate swaps and currency swaps.

•

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

•

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

SIGNIFICANCE OF DERIVATIVES Like other segments of Financial Market, Derivatives Market serves following specific functions:

•

Derivatives market helps in improving price discovery based on actual valuations and expectations. • Derivatives market transfers different risks from those who are exposed to risk but have low risk appetite to participants with high risk appetite. Like hedgers want to give away the risk where as traders are willing to take risk. • Derivatives market helps shift of speculative trades from unorganized market to organized market. Risk management mechanism provides stability to the financial system.

Various risks faced by the participants in derivatives Market Participants must understand that derivatives, being leveraged instruments, have risks like

    

Counterparty risk (default by counterparty) Price risk (loss on position because of price move) Liquidity risk (inability to exit from a position) Legal or regulatory risk (enforceability of contracts) Operational risk (fraud, inadequate documentation, improper execution, etc.)

5. FORWARD CONTRACTS It is an agreement made between two parties to buy / sell an asset on a specific date in the future, at the conditions decided today. Forwards are widely used in equity, interest rate markets, commodities & foreign exchange. The exchange happens at a specific price on a specific future date and the price is fixed by both the parties on the day they enter into contract. All the terms of the contract like price, quantity and quality of underlying, delivery terms like place, settlement procedure etc. are decided on the day of entering in contract.

To understand better let’s take an example to understand basic difference between spot market and forwards?

Assume on April 9, 2018 you wanted to purchase gold from a goldsmith. The market price for Gold on April 9, 2018 was Rs. 14,425 for 20 gram and goldsmith agrees to sell you gold at market price. You paid him Rs.14,425 for 20 gram of gold and took gold. This is a cash market transaction at a price (in this case Rs.14,425) referred to as spot price. Now suppose you do not want to buy gold on April 9, 2018, but only after 1 month. Goldsmith quotes you Rs.14,450 for 20 grams of gold. You agree to the forward price for 20 grams of gold and go away. Here, in this example, you have bought forward or you are long forward, whereas the goldsmith has sold forwards or short forwards.

There is no exchange of money or gold at this point of time. After 30 days, you come back to the goldsmith pay him Rs. 14,450 and collect your gold.

This is a forward contract, where both the parties are obliged to go with the contract irrespective of the value of the underlying asset (in this case gold) at the point of delivery.

Essential features of a forward are:

• It is a bilateral contract. • All terms of the contract like price, quantity and quality of underlying, delivery terms like place, settlement procedure etc. are decided on the day of entering in contract. In other words, Forwards are bilateral over-the-counter (OTC) transactions where the terms of the contract, such as price, quantity, quality, time and place are negotiated between two parties to the contract. Any changes in the terms of the contract are possible only if both the parties agree to it. Corporations, traders and investing institutions extensively use OTC transactions to meet their specific requirements. The main objective of entering into a forward is to cap the price and subsequently avoid the price risk. Thus, by entering into forwards, one is assured of the price at which one can buy/sell an underlying asset. In the above-mentioned example, if on May 9, 2018 the gold trades at Rs. 16,500 in the cash market, the forward contract becomes favourable to you because you can then purchase gold at Rs. 14,450 under the contract and sell in cash market at Rs. 16,500 i.e. net profit of Rs.2050. Similarly, if the spot price is 13,390 then you incur loss of Rs. 60 (buy price – sell price).

Forward contracts on foreign exchange are also very popular. Most large banks employ both spot and forward foreign exchange traders. Forward contracts are highly used to hedge foreign currency risk .Let’s say, if you are planning to place a trade between GBP( great Britain pound) and USD. Here GBP is the base currency and USD is the quote currency .Lets consider the spot and forward quotes for the USD/GBP exchange rate on May 6 2018 as follows. On spot market ,the bid price was 1.5541 and offer price was 1.5545. For three months forward the bid price is 1.5533 and offer price is 1.5538. Suppose on May 6 2018 ,the US corporation is liable to pay Euro 10 million in 3 months (august 6) .The corporation will agree to buy euro 10 million 3 months forward at an exchange rate of 1.5538. The corporation now has a long forward contract on GBP and it has agreed to buy the sum from the bank for 1.5538 million. Thus the bank now has a short forward contract on GBP. PAYOFFS FROM FORWARD CONTRACTS The payoffs can be positive or negative. This gives a better idea about the trader’s total loss and gain. The payoff from a long position in a forward contract on one unit of an asset is denoted as Pt-K . Where as the payoff from a short position in a forward contract on one unit is denoted as K-Pt. where K is the delivery price and Pt denotes the price of asset at contract maturity.

In the above example , the contract obligates the corporation to buy euro 10 million for 1553800 dollars. If the spot exchange rate rose to 1.6000 , the corporation earns a profit of 46200 dollars. At the same time if the spot exchange rate fell to 1.5000 at the end of 3 months , the forward contract would give a loss of 53800.This would lead to the corporation paying 53800 more than the market price.

Fig 2

5.2 MAJOR LIMITATIONS OF FORWARD CONTRACT Liquidity risk: As forwards are highly customized contracts i.e. the terms of the contract are according to the specific requirements of the parties, other market participants may not be interested in these contracts. The investment bank has to find a person who has an opposite view. The investment bank does this for a fee.

Counterparty risk: Counterparty risk is the risk of an economic loss from the failure of counterparty to fulfil its contractual obligation.This happens when the counterparty defaults. This is also called as default risk or counterparty risk.

Regulatory Risk : The forwards contract agreement is executed by a mutual consent of the parties involved and there is no regulatory authority governing the agreement .This may increase the incentive to default.

Rigidity: The rigidity of forward agreement is that they cannot foreclose the agreement halfway through. Future contracts were then designed to reduce the risk of forward agreements.

OPTIONS CONTRACT

Options are traded in the Indian markets for over 15 years, but the real liquidity was available only since 2006.An option is a tool for protecting your position and reducing risk. An option is a contract that gives the right but not an obligation, to trade the underlying asset on or before a stated date/day , at a stated price ,for a price. The party taking a long position i.e entering the option is called buyer/holder of the option and the party taking a short position i.e selling the option is called the seller/writer of the option.

A buyer of the call option has the right and the seller has an obligation to make delivery .The option buyer has the right but not the obligation with regards to buying or selling the underlying asset, while the option writer has the obligation in the contract.Therefore, option buyer/ holder will exercise his option only when the situation is favourable to him, but, when he decides to exercise, option writer would be legally bound to honour the contract. Options may be categorized into two main types:-

Call Options: Options, which gives buyer a right to buy the underlying asset Put Options: Options which gives buyer a right to sell the underlying asset

At the time of agreement the option buyer pays a certain amount to the option seller ,this is called the premium amount. The agreement happens at a pre specified price called the strike price.The option buyer benefits only if the price of the asset increases higher than the strike price. If the asset price stays at or below the strike price ,the buyer does not benefit and thus its always advisable to buy options when you really expect the prices would increase. Options are cash settled in India. Similar to futures contract, options contract also have an expiry. They expire on the last Thursday of every month. Option contracts have different expires- the current month, mid month and far month contracts. Buy a put option when you are bearish about the prospects of the underlying and when you are bullish on the underlying one can either buy a call option or sell a put option. The maximum loss the buyer of a call option experiences is to the extend of the premium paid. The loss is experienced as long as the spot price is below the strike price. The call option buyer has the potential to make unlimited profits provided the spot price moves higher than the strike price.The point at which the call option buyer completely recovers the premium he has paid that is called the breakeven point. The call option buyer truly starts making a profit only beyond the break even point. Selling a put option required you to deposit a margin. When you sell a put option your profit is limited to the extend of the premium you receive and your loss can potentially be unlimited.

Fig 3

6.1 OPTIONS TERMINOLOGY a) Index option: Options having index such as Nifty, Sensex, etc. as an underlying asset. b) Stock option: These options have individual stocks as the underlying asset. For example, option on ONGC, NTPC etc.

c) Buyer: Option Buyer is the one who has a right but not the obligation in the contract. For owning this right, he pays a price to the seller of this right called ‘option premium’.

d) Writer: Option writer is one who receives the option’s premium and is thereby obliged to sell/buy the asset if the buyer of option exercises his right.

e) Option price/Premium: It is the price which the option buyer pays to the option seller. In the above screenshot of nifty option, the premium amount is 1207.95.

f) Lot size: Lot size is the number of units of underlying asset in a contract. Lot size of Nifty option contracts is 50.

g) Expiry Day: It is the day on which a derivative contract expires. It is the last trading date/day of the contract. In our example, the expiration day of contracts is the last Thursday of every month i.e. for current month options will expire on 26 April, 2018.

h) Spot price (S): 10404.50 is the spot price for nifty here in the above example. It is the price at which the underlying asset is traded at the spot market.

i) Strike price or Exercise price (X): strike price for 9200 Call option is 9200. It is the price per share for which the underlying security may be purchased or sold by the option holder.

j) In the money (ITM) option: This option would give holder a positive cash flow, if it were exercised immediately. A call option is said to be ITM, when spot price is higher than strike price. And, a put option is said to be ITM when spot price is lower than strike price.

k) At the money (ATM) option: At the money option would lead to zero cash flow, if it were exercised immediately. Therefore, for both call and put ATM options, strike price is equal to spot price.

l) Out of the money (OTM) option: In other words, this option would give the holder a negative cash flow if it were exercised immediately. A call option is said to be OTM, when spot price is lower than strike price. And a put option is said to be OTM when spot price is higher than strike price.

m) Intrinsic value: Option premium, defined above, consists of two components - intrinsic value and time value. For an option, intrinsic value refers to the amount by which option is in the money i.e. the amount an option buyer will realize, before adjusting for premium paid, if he exercises the option instantly.

n) Time value: It is the difference between premium and intrinsic value, if any, of an option. ATM and OTM options will have only time value because the intrinsic value of such options is zero.

o) Open Interest: As discussed in futures section, open interest is the total number of option contracts outstanding for an underlying asset. For example 9200 CE has an open interest of 68475.

The table below shows the list of stock options registered under national stock exchange. The table also contains the respective underlying asset, expiry date , strike price and also data on open, high, low, prev close and last price.

. FUTURES CONTRACT Futures markets were innovated to overcome the limitations of forwards. A futures contract is an agreement made through an organized exchange to buy or sell a fixed amount of a commodity or a financial asset on a future date at an agreed price. Simply, futures are standardized forward contracts that are traded on an exchange. The clearinghouse associated with the exchange guarantees settlement of these trades. A trader, who buys futures contract, takes a long position and the one, who sells futures, takes a short position. The words buy and sell are figurative only because no money or underlying asset changes hand, between buyer and seller, when the deal is signed. Mostly future contracts are cash settled thus there is no worry of moving the asset from one place to another and there is total transparency in the cash settlement.

The futures agreement inherits the transactional structure of the forwards contract. A futures agreement derives its value from its corresponding underlying asset in the spot market. For example TCS futures derives its value from the underlying in the TCS share market. These are highly standardized contracts whose variables are predetermined- lot size and expiry date.

a) To enter into a futures agreement one has to deposit a margin amount ,which is a certain percent of the contract value. Margin allows us to deposit a small amount and take exposure to a large value transaction and hence leveraging on the transaction. b) When we transact in a futures contract ,we digitally sign the agreement with the counter party and thus becomes obliged to honor the contract upon expiry. c) The futures agreement is then tradable, the trader can hold it till the expiry or trade it in between. The trader can take a long position if he expects the price to go up and can go for a short if the prices will go down. d) Equity futures are always cash settled. Future agreements are called zero sum game because it allows one to transfer money from one pocket to another.

In the futures market ,all the trades are regulated by the exchange .The exchange in return takes the burden of guaranteeing the settlement of all the trades. The exchange makes sure that the people who are entitled to profits receive the same and also they ensure that they collect the money from the party who is supposed to pay up. They do this by collecting the margins and by marking the daily profits or losses to the market. The futures market in India is regulated by SEBI securities and exchange board of India.

7.1 FEATURES OF FUTURES CONTRACT In futures market, exchange decides all the contract terms of the contract other than price. Accordingly, futures contracts have following features:

• Contract between two parties through Exchange • Centralised trading platform i.e. exchange • Price discovery through free interaction of buyers and sellers

• Margins are payable by both the parties • Quality decided today (standardized ) • Quantity decided today (standardized) 7.2 FUTURES TERMINOLOGY a) Underlying asset: An underlying asset is a financial instrument from which a derivative derives its value.Underlying assets can be metals ,agricultural commodities ,stock, index etc. The futures price completely mimics the underlying as when the price of underlying goes up the price of futures also rises. Likewise when the price of underlying goes down the future price also comes down.

b) Spot price: This is the price at which the asset trades in the regular market or spot market.It is the current market price.For example if we are talking about gold as an underlying then the price of gold in spot market is spot price and gold in futures market is called gold futures.

c) Future Price: The price at which the asset is traded at futures market. d) Lot Size : Futures is a standardized contract where everything related to the agreement is predetermined. Lot size is one such parameter. Lot size specifies the minimum quantity that you will have to transact in a futures contract. Lot size varies from one asset to another.

e) Contract Value : Futures contracts are traded in lots and to arrive at the contract value we have to multiply the price with contract multiplier or lot size or contract size. Contract value = Futures price *Lot size.

f) Margin: Margin amount is a percent of contract value that is paid as a token advance in the beginning. It is paid for entering into the contract. Margin allows investors to deposit a small amount of money and take exposure to a large value transaction. This initial margin includes span margin and exposure margin.

a. At the time of initiating the futures position , margins are blocked in one’s trading account. b. The margins that get blocked are called the initial margin. c. The initial margin is made up of span margin and exposure margin d. Initial margin will be blocked in your trading account for how many ever days the trader choose to hold the trade.

g) Expiry :Future contracts are time bound .The expiry date of the futures contract is the date upto which the agreement is valid. It is the date till which the one can hold the future agreement. All derivative contracts in India expire on the last Thursday of the month.

h) Open Interest: Open interest is the total number of open or outstanding (not closed or delivered) options and/or futures contracts that exist on a given day, delivered on a particular day. It gives an idea of how many contracts are open and live in the market.

i) Hedging: This is a technique to ensure that your position in the market is not affected by any adverse movements. When a position is hedged it becomes neutral to the overall market position and thus this will neither make money nor lose money.

j) Bid and Ask prices :Bid prices are those provided by buyers who want to buy shares or futures .Ask prices are those quoted by sellers who want to sell shares or futures or other products at these prices, The difference between the ask and bid price is called as the spread.

k) Mark To Market (M2M) :Marking to market or mark or market is a simple accounting procedure which involves adjusting the profit or loss you have made for the day.

7.3 KINDS OF TRANSACTIONS IN FUTURES •

Opening buy means creating a long or buy position ,this happens when the investor believes that the stock prices would rise

• • •

Opening Sell means creating a Short Position .When we believe that the price of stock is going to decline ,we opt for a short position. Closing Buy means offsetting (fully or partly) an earlier Short Position Closing Sell means offsetting (fully or partly) an earlier Long Position Square off is closing an existing futures position. The square off for a buy open position would be to sell and the square off for for a sell is to go for a long position.

The table below shows the list of stock futures registered under National Stock Exchange. The table also contains the respective underlying asset, expiry date , strike price and also data on open, high, low ,previous close and last price.

4 CURRENCY FUTURES The future contracts on various currency pairs are knows as currency futures. Currently the future contracts that are available are : USD/INR, EURO/INR, GBP/INR and JPY/INR. These contracts are allowed to be traded on NSE and MCX. The contracts are very similar in nature and have to be cash settled .Some of the contract details are as follows : The symbols are USDINR ,EURINR, GBPINR and JPYINR , respectively. The underlying asset here is actually the exchange rate of the respective currencies in Indian rupees; It is the exchange rate for USD 1 in INR , EURO 1 in INR ,GBP 1 in INR and JPY 100 in INR.One unit of trading in currency futures denotes USD 1000 and the tick size is INR 0.0025(i.e 0.25 paisa ). The contract can be traded between 9am and 5:00 pm Monday to Friday .The contract trading cycle is a 12

month trading cycle with the last trading day being two working days prior to the last business day of the expiry month of the contract at 12:00 noon .

The final settlement day is the last working day (excluding Saturday ) of the expiry month.The base price is the theoretical price on the first day of the contract ; for all other days it is the daily settlement price , which is calculated based on the last half an hour weighted average price.The final settlement price is the Reserve Bank of India reference rate .Also the contract follows a “T+2” cycle for the final settlement.

The position limits for trading members are as follows :

 For USD/INR contracts , the limit is 15% of the toal open position or USD 50 million whichever is higher

 For EUR/INR contracts ,the limit is 15% of the total open position or Euro 25 million,whichever is higher

 For GBP/INR contracts ,the limit is 15% of the total open position or GBP 25 million , whichever is higher  For JPY/INR contracts , the limit is 15% of the total open position or JPY 1000 million , whichever is higher. The minimum initial margin is based on SPAN and the extreme loss margin is

• • • •

1% of the mark to market value of all open positions for USD/INR 0.3% of the mark to market value of all open positions for EUR/INR 0.5% of the mark to market value of all open positions for GBP/INR 0.7% of the mark to market value of all open positions for JPY/INR

7.5 SPECULATION USING FUTURES

Speculation is basically the act of trading in an asset that has a significant risk of losing money with the expectation of making a gain. The speculators wishes to take a position in the market. So speculators will either bet that the price of the asset will go up or they will bet that the price of the asset will go down. Lets consider a US speculator who in march thinks that the British pound will strengthen relative to the US dollar over the next two months and is planning to invest to the extend of 250000 pounds. One thing the speculator can do is to purchase 250000 pounds in spot market in the hope that the sterling can be sold at higher prices in the future market. Another alternative is to take a long position in four CME May futures contracts on sterling. Each futures contract is worth 62500 pounds.

Buy 250000 pounds Spot price=1.5470

Buy 4 futures contracts Future price=1.5410

Investment

$386750

$20000

Profit if May spot =1.6000

$13250

$14750

Profit if May spot=1.5000

-$11750

-$10250

The above table gives a picture about the profits and losses made on both the alternatives. If the rate increases to 1.6000 dollars per pound in May, the futures contract alternative enables the speculator to realize a profit of (1.6000-1.5410) *250000 = $14750. The spot market alternative leads to 250000 units of an asset being purchased for $ 1.5470 in March and sold for $1.6000 in April , so that a profit of ( 1.6000-1.5470 )*250000=$13250 would be made. At the same time consider a situation where the exchange rate falls to 1.5000 dollars per pound. The futures contract gives rise to a loss of ( 1.5410-1.5000)*250000= $10250 and the spot market alternative gives rise to a loss of (1.5470-1.5000) =$11750 .Thus it becomes very evident from the example that the futures alternative is favourable.The initial investment that was made in the spot market for buying sterlings were 250000*1.5470=$ 386750 .Whereas the investor just had to deposit a small sum of amount in the margin account. It was $5000 for one contract and thus $20000 for four futures contract.

7.6 OPERATION OF MARGIN ACCOUNTS One of the most important role of exchange is to organize trades , so that contract defaults are avoided .This is where margin accounts comes into picture. Margin allows us to deposit a small amount of money and takes exposure to a large value of transaction , thereby helping the trader to leverage on the transaction. The exchanges set the margin levels and are constantly required to review the rates as per the market volatility. The margin amounts can go up and down as well. The forwards market doesn’t have a regulator, but all the trades in futures market are routed through the exchange. The exchange here in return takes the burden of guaranteeing the settlement of all the trades. The exchange makes sure that the deserving party receives the amount . They ensure that they collect the money from the right party who is supposed to pay up.

At the time of initiating a futures position, the margins are blocked in the trading account .The margins that get blocked is called the initial margin .The initial margin is actually a combination of the Span margin and exposure margin. Initial margin would be blocked in the trading account

for how many ever days you choose to hold the futures trade .Span margin or maintenance margin is the minimum requisite margins blocked as per the exchange’s mandate .

Exposure margin is blocked over and above the span to cushion for any mark to market losses.It is collected as per the broker’s requirement .Both span and exposure are specified by the exchange. Span margin is more important as not having this in your account may lead to a penalty in the exchange .As the volatility rises , the span margin also rises. The moment the cash balance falls below the maintenance margin , they will call you asking you to pump in more money .In the absence of which they will force close the positions themselves .This call the broker makes requesting to pump in money is called the margin call. The margins vary from one underlying to the another. To illustrate how margin accounts work , we can consider an investor who contacts his broker to buy two December gold futures contracts.We can take current future price as 1450 per ounce . As the contract size is 100 ounces, the investor is required to buy a total of 200 ounces at this price. The broker will require the investor to deposit funds in a margin account .This fund deposited at the time of entering into the contract is known as initial margin .Let’s suppose thus us 6000 per contract and 12000 in total here .At the end of each trading day , the margin account is adjusted to reflect the investor’s gain or loss .This is known as the daily settlement or marking to market .

Suppose at the end of first day the futures price has dropped by $9 from $1450 to $1441. The investor here will have a loss of $ 1800 (200*9) , because the gold can now only be sold at $1441. The balance in the margin account will reduce to 10200 from 12000.A trade is first settled at the close of the day on which it takes place .It is then settled at the close of trading on each subsequent day.The investor has the full right to withdraw any balance in the margin account in excess of the initial margin.

The daily settlement is not just an arrangement between broker and client. Whenever there is a decrease in futures price , the margin account of an investor with long position would be reduced by that specific amount. In the example given here $1800 would be reduced from the investor’s account. The investor’s broker has to pay the exchange clearing house $1800 and this money is passed on to the broker of an investor with a short position. Similarly when there is an increase in the futures price ,brokers for parties with short positions pay money to the exchange clearing house and brokers for parties with long positions receive money from the exchange clearing house.

The exchange ensures that the balance in the margin account never becomes negative with the help of maintenance margin, which would be somewhat lower than the initial margin. At this point when the balance in the margin account falls below the maintenance margin , the investor receives a margin call and is expected to top up the margin account to the initial margin level by the end of the next day.The extra funds deposited are known as a variation margin .If the investor does not provide variation margin ,the broker closes out the position.

Here in the example , closing out the position involves selling off 200 ounces of gold for delivery in December.

The table given below illustrates the operation of margin account for one possible sequence of futures prices.The maintenance margin is assumed to be $4500 per contract or $9000 in total .On day 7 the balance in the margin account falls $1020 below the maintenance margin level.This leads to a margin call and the investor is supposed to add up $4020 to bring the account balance upto the initial margin level of $12000.The investor here provides this margin by the close of day 8. The contract is entered into on day 1 at $1450 and closed out on Day 16 at $1426.90.The margin is the only factor that provides confidence to market participants that others will meet the obligations on time. Table 1 Day

Trade Price

1

1450

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

1426.90

Settlement Price

Daily Gain

Cumulative Gain

Margin Account Balance 12000

1441.00 1438.30 1444.60 1441.30 1440.10 1436.20 1429.90 1430.80 1425.40 1428.10 1411.00 1411.00 1414.30 1416.10 1423.00

-1800 -540 1260 -660 -240 -780 -1260 180 -1080 540 -3420 0 660 360 1380 780

-1800 -2340 -1080 -1740 -1980 -2760 -4020 -3840 -4920 -4380 -7800 -7800 -7140 -6780 -5400 -4620

10200 9660 10920 10260 10020 9240 7980 12180 11100 11640 8220 12000 12660 13020 14400 15180

Margin Call

4020

3780

7. LEVERAGE Futures are highly leveraged products , this one factor makes futures more appealing and also a risky venture. Leverage here in futures trading means that the traders here have to pay only a small amount to the exchange to control a lot of product. The margin amount is only a small percentage of the contract value .This small amount facilitate the investors to take exposure for

a large value transaction. The higher the leverage, the higher is the risk and the higher is the profit potential.

The higher the leverage the higher is the risk .When leverage is high ,only a small movement in the underlying is required to wipe out the margin deposit Let’s understand the role of leverage in a better way with the help of an example considering two situations. Take for example , Mr M plans to buy shares of Infosys in spot market to the extend of 100000 . On 30th April 2018 , the Infosys share is traded at a price of 1168. Thus Mr M can afford to buy 86 shares of Infosys. 100000/1168 = 86 Now on May 7th , when Infosys is trading at 1300 .Mr M can square off the position for a profit of 11800 on investing 100000. 86*1300 =111800 , The return percentage would be 11800/100000=.1180 or 11.80 %

A return of 11.80 % on a 7 days time is a great thing. Now lets look at another alternative when Mr M decides to buy Infosys futures of 100000 worth in futures market .The minimum number of shares that needs to be bought in Infosys is 125 or in multiples of 12 .Thus the contract value is the lot size multiplies by the futures price .In this case the futures price is 1168 per share , hence the contract value becomes 125 *1168=146000. Here he doesn’t have to pay the entire contract value instead he only pays the margin amount and can enter the trade .The margin amount is a certain percent of contract value and here when we take a 14% , it happens to be 146000 *14%=20440. Thus Mr M can easily take 4 lots of the contract instead of 1 lot .Thus with 4 lots of Infosys futures the number of shares would be 500 (125*4)- at the cost of 81760.

Futures contract value at the time of buying =Lot size * number of lots *Futures Buy price =125*4* Rs 1168 =Rs 584000/Margin amount – Rs 81760 Futures Sell price = 1300 Futures contract Value at the time of selling = 125 *4*1300 =Rs 650000 Thus a profit of Rs 66000 Hence the return percent becomes [66000/81760] *100 =80.72%

That’s becomes a large amount of profit from Infosys futures .Thus the investor can earn a return of 80.72% from investing in futures market . The same person could only earn an approx. 12% return from investing in the spot market of the same security. Thus by virtue of margins,the investors can take positions much bigger than the actual capital available , this is called “Leverage”. Its like a double edged sword, if used in the right spirit and knowledge , it can lead to the creation of wealth or else can even wipe out your account. The higher the leverage ,the higher is the risk associated with the trade. When you are trading with a high leverage ,only a small move in the underlying is required to wipe out the margin deposit.

LEVERAGE CALCULATION The leverage calculated as follows :

Leverage =Contract value / Margin Hence for the above Infosys trade the leverage one lot is

146000/20440 =7.14

This means every Re 1 in the trading account can buy upto Rs7.14 worth of Infosys. This is a very manageable ratio.However if the leverage increases then the risk also increases. At 7.14 times leverage , Infosys has to fall by 14% for one to lose all the margin amount ,this is calculated as follows – =1/7.14 =14% Now for a moment assume the margin requirement was just Rs 5000 ,instead of 20440 .In this case the leverage would be =146000/5000 =29.2 times This is clearly a very high leverage ratio ,the investor would lose all his capital if Infosys falls by 1/29.2 =3.4% Here is this case , a 3.4% move in the underlying is enough to wipe out all your margin deposit.Alternatively , at 29.2 times leverage one just need a 2.4% move in the underlying to double your money.Thus the higher the leverage ,the higher is the risk. From the above

calculations its evident that , the more the margin the less would be the leverage associated with it .Whereas when the margin amount is less , the leverage would be high and thus more risky.

7.8 PAY OFF STRUCTURE The payoff structure plots a graph of the possible price on the day you bought the share versus the buyer’s profit and loss. In case of a long position -Any price above the buy price results in a profit an any price below the buy price results in a loss.If the trader has initiated a short position – then any price below the short price will result in a profit and any price above the short price lead to a loss.Since the traders here takes place trades in lots , just one point price movement results in a gain of (1* lot size ) and the same with a one point negative movement. The proportionality comes from the basic fact that the money made by the buyer is the loss suffered by the seller. The profit and loss is a smooth straight line thus its called as a linear pay off instrument.

The pay off for buyers of futures contract is similar to the pay off for a person who holds an asset. He has a potentially unlimited upside and downside as well. Consider for example the case of a speculator who buys a two month Nifty Index futures contrtact when the nifty stands at 1220 .The underlying asset in this case is the nifty portfolio .When the index moves up , the long futures position starts giving profits and when the index moves down it starts making losses. The graph below represents the pay off structure for futures during a long position. If SPm is the spot price on maturity and PP is the purchase price ,then the pay off on a long position per one unit of the asset is “SPM-PP”.

Fig 6

The payoff for a person who sells a future contract is similar to the payoff for a person who shorts an asset .For example take the case of a speculator ,who sells a two month Nifty index futures contract when the nifty stands at 1290 .The underlying asset in this case is the nifty index. When the index moves down ,the short futures position start making profits and when the index moves up , it starts making losses.

If SPm is the spot price on maturity and PP is the purchase price ,Then the pay off on a short position per one unit of the asset is “PP-SPm “ .

Fig 7

7.9 HEDGING WITH FUTURES A majority of the investors in futures market are hedgers . Their main motive is to use futures markets to reduce a particular risk that they face. Hedging position is undertaken by the investors inorder to eliminate the risk. When an individual or company chooses to use futures market to hedge a risk , the objective is to take a position that neutralizes the risk as far as possible .

Lets consider an example where an investor takes an hedging position against a single stock. Imagine if we bought 250 shares of Infosys at 2300 per share .This works out to be an investment of 575000. Here the investor is long on Infosys shares in the spot market.

After initiating this position , the investor realize that the quarterly results are expected soon.The investor is worried that Infosys may announce a not so favorable set of numbers , as a result of which the stock price may decline considerably .To avoid making a loss in the spot market , the investor decides to hedge the position.

Thus , in order to hedge the position in spot market , the investor here took a short position in the futures market for 250 shares at a price of 2301 per share.Thus the contract value becomes 575250 and the lot size is 250 . Now on one hand the investor is long on Infosys in spot market and on the other hand he is short on Infosys on futures market.Thus the investor could create a neutral position here.

Arbitrary price

Short on Futures P&L 2301-2200= 101

Net P & L

2200

Long on spot P&L 2200-2300= -100

2400

2400-2300= 100

2301-2400= -99

100-99= 1

2550

2550-2300= 250

2301-2550 = -249

250-249 =1

-100+101= 1

Fig 8

In the above figure , the investor has taken a long position in the spot market and a short position in the futures market. The above example neither make money nor lose money , the overall position is frozen here. In fact the position becomes indifferent to the market , this is why we say when a position is hedged it stays neutral to the overall market conditions . Hedging can be undertaken by buying in the spot market and selling in the futures market or else by taking a long position in the futures market and shorting in the spot market.

Short hedge A short hedge is a hedge , which involves a short position in future contracts .A short hedge is appropriate when the hedger already owns an asset and expects to sell it at some time in the future. Consider an example , assume that it is May 15 today and that an oil producer has has just negotiated a contract to sell 1 million barrels of crude oil .It has been agreed that the price that will apply in the contract is the market price on August 15.The oil producer is therefore in the position where it will gain $10000 for each 1 cent increase in the price of the oil over the next three months and lose $ 10000 for each 1 cent decrease in the price during this period . Suppose that on May 15 the spot price is $80 per barrel and the crude oil futures price for august delivery is $79 per barrel, Because each futures contract is for the delivery of 1000 barrels, the company can hedge its exposure by shorting 1000 futures contract .If the oil

producer closes out its position on August 15, the effect of the strategy should be to lock in a price close to $79 per barrel. Suppose if the spot price on August 15 proves to be $75 per barrel .The company realizes $75 million for the oil under its sales contract .Because August is the delivery month for the futures contract , the futures price on August 15 should be very close to the spot price of $75 on that date. The company therefore gains approximately

$79-$75 = $4 per barrel or $4 million in total from the short futures position. The total amount realized from both the futures position and the sales contract is therefore approx. $79 per barrel or $79 million in total. Suppose the price of oil on August 15 proves to be $85 per barrel .The company realizes $85 per barrel for the oil and loses approximately $85-$79=$6 per barrel. Again the total amount realized is approximately $79 million .

Long Hedges Hedges that involve taking a long position in a futures contract are known as long hedges. A long hedge is appropriate when a company knows it will have to purchase a certain asset in the future and wants to lock in a price now. Lets consider an example ,assume that it is January 15 now.A copper fabricator knows it will require 100000 pounds of copper on May 15 to meet a certain contract .The spot price of copper is 340 cents per pound , and the futures price for may delivery is 320 cents per pound .The fabricator can hedge its position by taking a long position in four futures contracts offered by the COMEX division of the CME group and closing its position on May 15.Each contract is for the delivery of 25000 pounds of copper .The strategy has the effect of locking in the price of the required copper at close to 320 cents per pound.

Suppose that the spot price of copper on May 15 proves to be 325 cents per pound. Because May is the delivery month for the futures contract , thus should be very close to the futures price .The fabricator therefore gains approximately 100000 *( $3.25 -$3.20)= $5000 on the futures contract.

It pays 100000 *$ 3.25= $ 325000 for the copper ,making the netcost aprroximately $325000$5000 = $ 320000. For an alternative outcome , suppose that the spot price is 305 cents per pound on May 15. The fabricator then loses approximately 100000 *($3.20- $3.05) =$15000.

On the futures contract and pays 100000 * $3.05 = $305000 for the copper .Again , the net cost is approximately $320000 or 320 cents per pound.

7.10 OPEN INTEREST The open interest is the total number of open or outstanding contracts on a particular day. It gives the investors an idea about all the open and live positions in the market.When a buyer is said to be long on a position and the seller is said to be short on the same contract , then the open interest becomes one.The open interest helps the investors in knowing about the liquidity in the market. The more the open interest the more would be the liquidity .Thus it helps the traders to enter and exit trades at competitive bid/ask rates.

Fig 9

Just have a look at the above snapshot . As of May 7 2018 , the open interest on nifty futures is 2.38 crores . The change is open interest gives data on the number contracts added on a particular day .Here a total 244125 contracts have been added or that make up a 1.03% on 2.38 crores.People gets confused with volumes and open interests . Volumes starts from zero every

day whereas open interest is not discrete like volumes. It gets on increasing and decreasing based on the entry and exit orders of traders. When there is an increase in both the price and volume , the market is tend to be bullish.When both the price and volume are decreasing the traders will will think that the bearish trend could probably end can expect a reversal. Another situation can be when the price decreases along with an increase in the volume ,this leads to a bearish trend. The status of open interest can give a sense of strength between bullish and bearish positions. If there is an abnormally high open interest backed by a rapid increase or decrease in prices , then the investor has to be cautious as a very small trigger can lead to a lot of panic in the market. Now lets look at the trader’s perception when there is a change in the price of the stock and the open interest

Price Increase Decrease Decrease Increase

Open Interest Increase Decrease Increase Decrease

Trader’s Perception More trades on the long side Longs are covering up their positions ,long unwinding More trades on the short side ,bearish Shorts are covering their position , short covering

7.11 DELIVERY A very few futures contracts that are entered into lead to delivery of the underlying asset. Most are closed out early The period during which delivery can be made is defined by the exchange and varies from contract to contract .The decision on when to deliver is made by the party with the short position,whom we can refer here as investor A .When this investor A decided to deliver , investor A’s broker issues a notice of intention to deliver to the exchange clearing house. This notice states how many contracts will be delivered and in the case of commodities ,it also specifies where delivery will be made and what grade will be delivered. The exchange then chooses a party with a long position to accept delivery .

Suppose that the party on the other side of investor A’s futures contract when it was entered into was investor B. It is very important to know that , its not necessary to expect investor B to take the delivery .Investor B may have closed out his or her position by trading with investor C. Same with investor C as well , investor C must have closed his or her position by trading with investor D and so on. The usual rule of the exchange is to pass the notice of intention to deliver on to the party with the oldest outstanding long position. Parties with long positions must accept delivery notices. However, if the notices are transferable ,the long investors have a short period of time , usually half an hour , to find another party with a long position that is prepared to take delivery in place of them.

In case of commodities ,taking delivery usually means accepting a warehouse receipt in return for immediate payment .The party taking delivery is then responsible for all warehousing

costs.In the case of livestock futures , there may be costs associated with feeding and looking after the animals. In the case of financial futures, delivery is usually made by wire transfer .For all contracts ,the price paid is usually the most recent settlement price. If specified by the exchange , this price is adjusted for grade , location of delivery and so on .The whole delivery procedure from the issuance of the notice of intention to deliver to the delivery itself generally takes about two to three days. There are three critical days for a contract .These are the first notice day , the last notice day and the last trading day.The first notice day is the first day on which a notice of intention to make delivery can be submitted to the exchange .The lase notice day is the last such day .The last trading day is generally a few days before the last notice day .To avoid the risk of having to take delivery, an investor with a long position should close out his or her contracts prior to the first notice day. A futures contract is referred to by its delivery month .The exchange must specify the precise period during the month when delivery can be made. For many futures contracts , the delivery period is the whole month .The delivery months vary from contract to contract and are chosen by the exchange to meet the needs of market participants. At any given time, contracts trade for the closest delivery month and a number of subsequent delivery months.

7.12 CASH SETTLEMENT Mostly all the financial futures are cash settled , such as those on stock indices are settled in cash because it is inconvenient or impossible to deliver the underlying asset .In the case of futures contract on the S&P 500 , for example delivering the underlying asset would involve delivering a portfolio of 500 stocks. When a contract is settled in cash, all outstanding contracts are declared closed on a predetermined day.The final settlement price is set equal to the spot price of the underlying asset at either the open or close of trading on that day.

Technical analysis The technical analysis helps to identify the trading opportunities using actions of market participants through charts, indicators and patterns. The concept of technical analysis can be used to analyse any asset class – equities, foreign exchange, commodities etc. The few key assumptions of technical analysis are market discounts everything, price moves in trends and history tends to repeat itself. The types of charts used to analyse trade patterns are bar charts, line charts and Japanese candle stick charts. The Japanese candle stick charts are the most popular and the widely used charts to analyse any market. In a Japanese candle stick chart, strength is represented by a bullish candle and weakness by a bearish candle. Some of the widely used indicators are Relative strength index , Fibonacci retracement , moving averages and pivot point. Technical analysis can be used to analyse various underlying assets to decide on a derivative trade with the help of various technical indicators. Because the prices of the

derivatives and their underlying assets moves in tandem. Technical analysis facilitates the study and understanding of candle sticks and various technical indicators. Fig 10

8.1 JAPANESE CANDLE STICK CHARTS The earliest use of candlesticks dates back to the 18th century by a Japanese rice merchant named Homma Munehisa. Though the candlesticks have been in existence for a long time in Japan, the western world traders were clueless about it. In 1980’s a trader named Steve Nison accidentally discovered candle sticks and he introduced this to the rest of the world. He published the book named “Japanese candlestick charting Techniques” and the candle stick techniques began to gain popularity in the 90’s. The Japanese candle stick charts are widely used around the world to conduct technical analysis. Japanese candle sticks can be used for any time frame including one day , one hour ,30 minutes etc. The candle sticks are classified into bullish candle and bearish candle. The bullish candle is mostly represented by green/blue/white and bearish as red/black. They are formed using the high, low, open and close of the chosen time period. If the close is above the open ,then a hollow/green candlestick is formed called a bullish candle. If the close is below the open , then a red/ black candlestick is formed called a bearish candle. Bullish candle indicates strength and thus it gives buy signals , whereas a bearish candle indicates weakness and thus go for a short. Every candlestick consists of three components namely the

• • •

Central real body: The rectangular shaped real body that connects the opening and closing price Upper shadow: connects the high to the close in case of bullish candle and connects the high to the open for a bearish candle Lower Shadow: It connects the low to the open in case of a bullish candle and connects the low to the close for a bearish candle.

8.2 SINGLE CANDLESTICK PATTERNS 8.2.1 MARUBOZU: The marubozu is a candle with no upper and lower shadow. It will just have a real body. This can be classified into bullish marubozu and bearish marubozu. When the open is equal to the low and high is equal to the close, a bullish marubozu is formed. It shows that there is so much buying interest in the market and the market participants are willing to buy the stock at every price point during the day. In a bearish marubozu the open is equal to the high and the close is equal to the low. It shows that there is so much selling pressure in the market and the participants sold at every price point during the day.

Fig 11

8.2.2 THE SPINNING TOP: These candles have a small real body with equal upper and lower shadows.It conveys indecision and uncertainity as both bulls and bears were not able to influence the market. If the bulls were successful then the real body would have been a long green candle.If the bears were successful then the real body would be a long red candle.The presence of upper and lower shadow tells us that the bulls and bears have tried their best. Whenever the spinning top pattern forms , the

traders will have to wait for the next price movement.In an uptrend if a bullish candle is formed soon after the spinning top pattern at a support level ,the investor can go for a long position . Fig 12

8.2.3 THE DOJI In doji candles the open price and the close price will be equal.The upper and lower shadow can be of any size.Doji candles conveys indecisions and uncertainity , in this case the market can swing in both ways. Prices move either above and below the open price during the session, but close at or very near the open price.There are four types of Doji candles namely long legged doji, dragonfly doji, gravestone doji and four price doji.

8.2.4 PAPER UMBRELLA In a paper umbrella the length of the lower shadow should be at least twice the length of real body. It appears with a small real body and a long lower shadow. A paper umbrella consists of two trend reversal patterns namely the hanging man and the hammer .The hammer is a bullish trend reversal pattern that forms during downtrend and the hanging man is a bearish trend reversal pattern that appears in an uptrend. The chart below shows both the hanging man and the hammer along with their respective trends.

Fig 14

THE HAMMER This candle stick appears at the bottom end of a downward trend and is relatively bullish. The length of the lower shadow be atleast twice the length of the real body.The low of the hammer is taken as the stop loss.The true confirmation of a hammer candle can only be made when the next proceeding candle closes with a higher low than the hammer candle. The price action on the hammer formation day indicates that the bulls were reasonably successful in taking the price higher. Thus traders can look for buying opportunities. The hammer is a bullish reversal pattern and it’s named so as it acts like hammering out a bottom. The main points to be considered include

   

The long shadow has to be two or three times of the real body There would be little or no upper shadow The real body is at the upper end of the trading range The color of the real body doesn’t matter, but a bullish candle is mostly preferred.

Fig 15

8.2.5 THE HANGING MAN This candlestick appears at the top end of a upward trend and is relatively bearish.The length of the lower shadow should be atleast twice the length of the real body.The day the hanging man candle appears , it shows that the bears have managed to make an entry.The hanging man formation does not mean that the bulls have definitely lost control ,but it may be an early sign that the momentum is decreasing and the direction of the asset may be getting ready to change. It is more easily identified in intraday charts than daily charts.Thus it’s highly used by intraday traders. Thus it suggests a short trade and the stop loss would be the high of the hanging man.

Fig 16

The main features to be noted while looking for an hanging man are as follows :

   

A long lower shadow which is two to three times of the real body. Little or no upper shadow The real body has to be in the upper end of the trading range The colour of the body doesn’t matter , anyhow a bearish candle is more preferable.

8.2.6 INVERTED HAMMER An inverted hammer is a bullish reversal candlestick .The inverted hammer is formed in the downward trend. It appears with a longer upper shadow , which is atleast twice the body’s length.The trader can think about taking a long position and the stop loss could be kept at the low of the inverted hammer.It indicates that the bulls have made an entry and the buyers have tried to take the price higher.

Fig 17

8.2.7 THE SHOOTING STAR This candlestick has a longer upper shadow and the length of the upper shadow is atleast twice the length of the real body.It’s a bearish pattern and thus the prior trend has to be bullish. On the day the shooting star pattern forms, the market would make a new high. But at the high point ,there is a selling pressure which lead the price to close near the low point .Thus it indicates that the bears have made an entry and they could push the prices down.Thus it gives the trader selling opportunities and the stop loss to be kept at the high of the pattern.

Fig 18

8.3 MULTIPLE CANDLESTICK PATTERNS 8.3.1 Bullish Engulfing Pattern : It appears at the bottom of a downtrend and is considered to be bullish. Bullish engulfing pattern evolves over two days , the first day of the pattern should be a red candle and the second day candle would be a green candle.Its not necessary for the green candle to engulf the shadows but the real body of the red candle would be completely engulfed.The traders can initiate a long position and the stop loss has to be the lowest of the pattern.

8.3.2 Bearish Engulfing Pattern This bearish pattern appears at the top end of an uptrend and thus the prior trend has to be bullish.This is also evolved over two days , on the first day a bullish candle is formed followed by a long bearish candle that completely engulfs it.This means that the sellers are more powerful than the buyers and that the prices can come down.The traders can look for selling oppurtunities and the stop loss has to be at the highest of the pattern.

Fig 19

8.3.3 THE PIERCING PATTERN This is very similar to the bullish engulfing pattern with a small variation. In a piercing pattern the green candle formed on the second day partially engulfs the red candle formed on the first day. The engulfing happens between 50% and less than 100 %. The traders can look for buying opportunities and the stop loss to be kept at the low of the pattern.

Fig 20

8.3.4 THE DARK CLOUD COVER This is very similar to bearish engulfing pattern with a slight variation. In a dark cloud cover pattern the red candle formed on the second day engulfs the green candle partially about 50%100% . The traders can look for selling opportunities and the stop loss would be the high of the pattern.

Fig 21

8.3.5 THE HARAMI PATTERN Harami is the old Japanese word for pregnant. Its a two candle pattern with the first candle being usually long and the second candle has a small body. There are two types of harami patterns –the bullish harami and the bearish harami.

a) THE BULLISH HARAMI This candle is formed in a downtrend pushing the prices lower ,therefore giving the bears more control over the market.But on the second day the market gains strength and thus manages to close on a positive note , thus forming a green candle. The small green candle formed on the second day appears pregnant within the long red candle.Traders can initiate a long position and can keep the stop loss at the lowest low of the pattern.Risk takers can initiate a long trade around the close of the green candle on second day.

b) THE BEARISH HARAMI This candle is formed at the top end of an uptrend. A bullish candle is formed on the first day and a red candle on the second day. The small red candle formed on the second day appears pregnant within the long blue candle. The opening price of the red candle should be lower than the closing price of the green candle. Traders can look for selling opportunities and the stop loss to be kept as the highest high of the pattern. This picture shows the bullish and the bearish harami respectively. Fig 22

8.4 TRIPLE CANDLE STICK PATTERNS 8.4.1 THE EVENING STAR This is a bearish candle stick pattern that evolves over a three day period and it appears at the top of an uptrend. The first candle would be a bullish candle followed by a doji or spinning top with a gap up opening. The third candle would be a bearish candle with a gap down opening and the current market price should be lower than the opening price of first candle. The traders can initiate a short position and the stop loss has to be the highest high of the pattern.

In an evening star pattern , the trader has to look for the following :

 The first candlestick is a bullish candle ,which is a part of a recent uptrend.  The second candle must have a small body , this candle can either be bullish or bearish. This candle shows perfect indecision in the market.  The third candlestick is an absolute bearish one and it closes beyond the midpoint of the first candle.

Fig 23

8.4.2 THE MORNING STAR This is a bullish candle stick pattern that evolves over a three day period and it appears at the bottom of a downtrend. The first candle would be a bearish candle followed with a gap down opening ,the second candle would either be a doji or a spinning top.The third candle would be a bullish candle and the current market price being higher than the opening of the first candle.The traders can look for buying opportunities and the stop loss has to be the lowest low of the pattern. A trader can look for the following signals in order to confirm regarding this pattern .

 The first candle is a bearish candle that is formed at the top of an uptrend  The second candle is a small and indecisive candle stick. This can be a bearish or bullish candlestick .  The third candle is any long or bullish candle.

Fig 24

Fig 25

9. TECHNICAL INDICATORS Technical indicators helps the investors to analyse the price movements of securities and hence leads to more accurate trading decisions. Indicators are of two kinds mainly leading indicator and lagging indicator. The leading indicator leads the price and thus it signals the occurrence of a reversal or a new trend in advance. Lagging indicators lags the price and thus it usually signals the occurrence of a reversal or a new trend after it has occurred. The trader has to be highly alert while using technical indicators because no indicator can give complete true signals. The efficiency of technical indicators also increases along with the trade experience. Some of the most widely used indicators are Pivot points ,Fibonacci Retracement, Moving averages, Bollinger Bands ,Relative strength Index and stochastic Oscillator.

Fig 26

9.1 RELATIVE STRENGTH INDEX : The relative strength index or RSI is a very popular indicator developed by J.Welles Wilder. RSI is a leading momentum indicator which helps in identifying a trend reversal .RSI indicator oscillates on a scale of 0 and 100, and based on the latest indicator reading , trade positions are decided. The formula to calculate the RSI is as follows RSI = 100- 100/1+RS RS= Average Gain /Average Loss Wilder’s formula normalizes relative strength and turns it into an oscillator that fluctuates between 0 and 100 .The Relative strength index indicator can be broken down into relative strength , average gain and average loss. The RSI calculation is based on 14 periods ,which is the default time frame suggested by Wilder .Losses are expressed as positive values , not negative values.

The very first calculations for average gain and average loss are simple 14 period averages.First average gain is the sum of gains over the past 14 periods divided by 14. And the first average loss is the sum of losses over the past 14 periods divided by 14. The second set of calculations

are based on the prior averages and the current gain or loss. Here the Average gain =[(previous average gain)*13+ current gain] /14. Average loss=[(previous average loss )*13 +current Loss ] /14 Taking the prior value with the current value is part of smoothing technique similar to that used in calculating the exponential moving average. The RSI values become more accurate as the calculation period extends.The RSI is normally zero when the Average gain equals zero .Assuming a 14 period RSI , a zero RSI value means price moved lower all 14 periods .There wasn’t any gains to measure .The RSI is 100 when the average loss equals zero .This indicates that the prices moved higher on all 14 periods and there were no losses to measure. A value between 0 and 30 is considered oversold and thus the trader should start looking for buying opportunities. Any value between 70 and 100 is considered to be overbought and the trader can look for selling opportunities. If the RSI value is fixed in the overbought region for a long period that shows an excess of positive momentum and the trader can go for a long position .If the RSI value stays in the oversold region for a long time that shows the excess of negative momentum and can thus go for a short.The below graph is the candle stick chart of nifty futures along with RSI indicator. Fig 27

Wilder says divergences signal a potential reversal point , thus RSI considers the bullish divergence and bearish divergence as well. A bullish divergence occurs when the underlying security makes a lower low and the RSI forms a higher low.The RSI indicator here is not confirming the lower low and this shows strengthening momentum. A bearish divergence is formed when the security records a higher high and the RSI forms a lower high .Here the RSI is

not accepting the newer high and thus shows the weakening momentum. The chart below shows a bearish divergence during august –october and a bullish divergence during January – March. 9.2 MOVING AVERAGES The moving averages are one of the widely used technical indicators ,used to identify the buying and selling oppurtunities. When the stock price trades above its average price ,it means the traders are willing to buy the stock at a higher price than its average price. Therfore the trader can look for buying oppurtunities. We use exponential moving averages to analyse the market. For example take 50days EMA.The trader has to go for a long position ,when the current market price turns greater than the 50day ema and can exit the long position when the price is less than the 50 day EMA.Moving averages can be calculated on any time frame.

Simple moving averages (SMA), exponential moving average(EMA) and weighted moving average (WMA) are the three types of moving averages. For stocks ,common time periods for moving averages are 10 days ,21 days, 50 days, 100 days and 200 days. The most commonly and widely used moving average is the simple moving average. Single simple moving average can be used to identify a trend , but dual or triple moving averages combined together is more powerful and effective.

Traders makes use of moving average cross over system ,by combining two moving averages of different time frames. Thus is usually referred to as smoothing. The shorter moving average (50day MA) takes lesser number of data points to calculate the average and hence it always sticks closer to the current price. Whereas the longer moving average (100 day MA) takes more data points to calculate the average and thus it tends to stay away from the current price. When the short term moving average turns greater than the long term moving average, the trader can take a long position. When the short term moving average turns lesser than the longer term moving average, the trader goes for a short position. The entire outlook turns bullish, when the faster EMA is above the slower EMA and it looks bearish when the faster EMA is going below the slower EMA. The below graph is the candle stick chart of Nifty futures. The green line on picture below indicates a 50 day moving average and the red line denotes a 100 day moving average.

Fig 29

9.3 FIBONACCI RETRACEMENT Under this indicator technical analysis is carried out with the help of certain ratios i.e 61.8% ,38.2% and 23.6%.These retracement level provide a good opportunity for the traders to enter into new positions. This analysis is used by traders when there is a noticeable up- move or down-move in prices. We should first identify the 100% Fibonacci move. This move can be an upward or a downward rally. Traders need to pick the most recent peaks and trough on the chart. Once these points are identified, these are connected using a Fibonacci Retracement tool. These ratios act as a potential level upto which a stock can correct. This indicator enable the traders to identify the retracement levels and therefore helps to position accordingly. This indicator can help the investor to decide on stop loss and take profit as well.

Fig 30

9.4 STOCHASTIC OSCILLATOR This momentum Oscillator was created by George Lane in the late 1950s. The stochastic oscillator presents the location of the closing price of a stock in relation to the high and low range of the price of a stock over a period of time ,typically a 14 day period. He originally designed the oscillator to follow the momentum of price but now its more popularly used to identify the overbought and oversold conditions. The stochastic is scaled from 0 to 100.When the stochastic lines are above 80 usually denoted by a red line ,then the market is said to be overbought. When the lines are below 20 usually denoted by a blue line ,then the market is said to be oversold. The overbought readings are not necessarily bearish , because this can remain overbought during a strong uptrend. In a similar way, oversold readings are not always bullish , this can remain oversold and remain oversold during a strong downtrend.

Closing levels that are consistently near the top of the range indicate accumulation of buying pressure and those near the bottom of the range indicate distribution or selling pressure. The key concept behind this indicator is that in an upward trending market , prices tend to close near their high and during a downward trending market, prices tend to close near their low.The stochastic oscillator is set at 14 periods by default ,which can be days ,weeks ,months

or an intraday timeframe. A 14%K would use the most recent close ,the highest high over the last 14 periods and the lowest low over the last 14 periods .The %D is the 3 day moving averages of %K. This line is plotted alongside %K to denote as a signal or trigger line. The below graph is the candle stick chart of Nifty futures along with stochastic oscillator indicator.

Fig 31

9.5 PIVOT POINTS The pivot point is a technical analysis indicator used to determine the overall trend of the market over different time frames.We calculate the pivot point of a stock by taking the average of the opening ,closing , high and low of the previous candle. On the subsequent day ,trading above the pivot point is considered to indicate bullish sentiments and trading below the pivot point indicates bearish sentiments. It helps the trader to find out the support and resistance levels and also to plan for the stop loss and take profit points. The other types of pivot points

include the Woodie’s pivot point , classical or standard pivot point , Fibonacci pivot point and camarilla pivot point. The pivot points and the associated support and resistance levels are calculated by using the last trading session’s open ,high, low and close.

The calculation for a pivot point are as follows: Pivot point (PP) = (High +Low +Close )/3 The support and resistance levels are then calculated . First level support and resistance: First resistance (R1) =(2*PP)- Low First support (S1)=(2* PP)-High

Second level of support and resistance: Second resistance (R2) =PP +(High –Low) Second Support (S2) =PP-(High –Low)

Third level of support and resistance: Third resistance(R3)= High +2(PP-Low) Third Support (S3) =Low -2(High-PP)

9.6 BOLLINGER BANDS Bollinger Bands , a technical indicator developed by John Bollinger is used to measure the volatility of the market. When the market is quiet ,the bands contract and when the market is loud, the bands expand. These are mostly used to determine the overbought and oversold levels, where a trader will short when the price reaches the top of the band and will execute a long position when the price reaches the bottom of the band. The band automatically widens with the increase in the volatility and it narrows as the volatility decreases. The investors use the Bollinger bands to identify various signals including the W bottoms , M bottoms and to determine the strength of the trend.

The Bollinger bands has three components : the middle line is the 20 day moving average of the closing prices, an upper band is the +2 standard deviation of the middle line and the lower band is the -2 standard deviation of the middle line. The middle band is a measure of the intermediate term trend ,usually a simple moving average that serves as the base for the upper band and lower band. The interval between the upper and lower bands and the middle band is determined by volatility. The middle band is a simple moving average that is usually set at 20 periods. A simple moving average is used because the standard deviation formula also uses a simple moving average.The outer bands are usually set 2 standard deviations above and below the middle band.The below graph is the candle stick chart of Nifty futures along with Bollinger bands indicator. Fig 32

The formula can be simplified as follows : Middle band =n- period moving average Upper band =Middle band + (y *n-period standard deviation) Lower band =Middle band- (y*n-period standard deviation ) Where: n= number of periods Y=factor to apply to the standard deviation value (y=2)

W bottom signal

This was developed by Arthur Merril ,who identified 16 patterns with a basic W shape .A WBottom forms in a downtrend and involves two reaction lows. The second low must be lower than the first bottom ,but it has to be above the lower band. Second there has to be a bounce towards the middle band .The next low formed must be lower than the initial one and it should be above the lower band. Finally the the pattern shows a strong upward trend. Bolinger bands are calculated on closing prices so signals should also be based on closing prices .

Fig 33

M tops signal This signal was also part of Arthur Merril’s work that identified 16 patterns with a basic M shape. M top pattern is similar to a double top. The highs of the pattern may not be always equal .The first high can be higher or lower than the second high .This is the exact opposite of W bottoms. At first a security creates a reaction high above the upper band , followed by a pullback towards the middle band.Third ,the prices move above the prior high but fails to reach the upper band.This is a warning sign for the investor .The inability of the second high to reach the upper band shows the declining momentum and may lead to a trend reversal. The final confirmation comes up with a support break or a bearish indicator signal.

Fig 34

Walking the bands signal When the pattern touches the upper band after the Bollinger band confirms a W –Bottom would signal the start of an uptrend. The 20 day simple moving average line acts as a support . The dip below the 20 days SMA provides buying opportunities to the investor. There would be instances where pattern goes in a downtrend after an M top formation. The stock would not be closing above the upper band rather would close below the lower band .Here he support break and the initial close below the lower band signals a downtrend.

Fig 35

10. LIMITATIONS

•

Futures are expensive and highly leveraged products that carries high risks , thus investors/traders are not always active like stock market traders.

•

Futures contracts carry definite expiration dates , thus whatever the established fixed price be , it may appear less attractive when the expiry dates are near.

•

Futures were mainly introduced for hedging purpose in the market , but it has been used for speculation by retail investors ,thus leading to unnecessary volatility and price movements in the market .

•

Forex market provide the maximum leverage and are thus highly risky products. Thus an highly leveraged bet in forex can lead to a huge loss.

•

The Japanese candle sticks look different on every time frame. Thus it’s difficult to trust them completely on different time frames.

•

The candle sticks are a lagging indicator.

•

Technical indicators may give mixed signals , if they are used in isolation. Thus its always better to use a combination of indicators and patterns .

•

Technical indicators are mostly based on probability, thus it’s not always necessary to be correct even after a thorough analysis.

•

A single trading strategy may not be work out in all situations in the market .The strategies needs to be updated and revised as per the market.

•

Investors can neither be completely reliable on candle sticks nor on technical indicators.

INTRODUCTION OF OPTIONS: In this section, we look at the next derivative product to be traded on the NSE, namely options. Options are fundamentally different from forward and futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Whereas it costs nothing (except margin requirement) to enter into a futures contracts, the purchase of an option requires as up-front payment.

DEFINITION: Option is a type of contract between two persons where one grants the other the right to buy a specific asset at a specific price within a specific 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 premium. The assets on which option can be derived are stocks, commodities, indexes etc. If the underlying asset is the financial asset, then the option are financial option like stock options, currency options, index options etc, and if options like commodity option.

PROPERTIES OF OPTION:

  

Options have several unique properties that set them apart from other securities. The following are the properties of option: Limited Loss High leverages potential Limited Life

PARTIES IN AN OPTION CONTRACT: BUYER/HOLDER/OWNER OF AN OPTION: The buyer of an option is one who by paying option premium buys the right but not the obligation to exercise his option on seller/writer.

SELLER/WRITER OF AN OPTION: The writer of the 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 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 option are divided into two types: 

INDEX OPTIONS: These options have the index as the underlying. Some options are European while others are American. Like index futures contract, index options contracts are also cash settled.



STOCK OPTIONS: Stock options are options on the individual stocks. Options currently trade on over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price

II.

ON THE BASIS OF THE MARKET MOVEMENTS: On the basis of the market movements the option are divided into two types. They are:



CALL OPTION: A call option is bought by an investor when he seems that the stock 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 OPTION: On the basis of the exercised 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 option are American. EUOROPEAN OPTION: European options are options that can be exercised only on the expiration date itself. European options are easier to analyze than American options, and properties of an American option are frequently deduced from those of its European counterpart.

FACTORS EFFECTING THE PRICE 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 a amount by which the stock price exceeds the strike price. Call options therefore become more valuable 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 valuable as the stock price increases and vice versa. Strike price: In case of a call, as a 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 option becomes less valuable and as strike price decreases, option become more valuable. Time to expiration: Both put and call American options become more valuable as a time to expiration increases. Volatility: The volatility of a stock price is measured 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 options prices decline as the risk-free rate increases where as the prices of call always increase as the risk-free interest rate increases. Dividends: Dividends have the effect of reducing the stock price on the x-dividend rate. This has a negative effect on the value of call options and a positive effect on the value of put options.

DIFFERENCES BETWEEN FUTURES & OPTIONS: FUTURES

OPTIONS

1.Exchange traded, with Novation 2.Exchange defines the product 3.Price is zero, strike Price moves 4.Price is zero 5.Linear payoff 6.Both long & Short at risk

1.Same in nature 2.Same in nature 3.Strike price is fixed, price moves 4.Price is always positive 5.Nonlinear payoff 6.only short at risk

Table : 4.2

5.DATA ANALYSIS & INTERPRETATION: The Objective of this analysis is to evaluate the profit/loss position futures and options. This analysis is based on sample data taken of M/s. KOTAK STOCK BROCKING LIMITED scrip. This analysis considered the May contract of kotak. The lot size of kotak is 100, the time period of the analysis is, from 11-05-2012 to30-06-2012. Table : 5.1 KOTAK STOCK FUTURES & OPTIONS PRICE

CALL OPTION

PUT OPTION

(2)

(3)

(4)

DATES (1)

May/fri/11 May/sat/12 May/sun/13 May/mon/14 May /tue/15 May /wed/16 May /thu/17 May /fri/18 May/sat/19 May/sun/20 May/mon/21 May /tue/22

SPOT

FUTURE

740

742.00 742.80

738.85 740.20

780.00 785.00 815.55 848.00 845.00 776.55

770.05 822.95 823.15 855.70 848.75 774.55

767.70 700.00

712.30 685.40

48.45 25.35 14.00 65.15 30.35 17.00 TRADING HOLIDAY 55.25 32.25 16.30 94.00 51.80 31.90 108.20 55.15 32.80 0 75.80 48.50 123.00 71.35 42.25 0 32.60 19.05 TRADING HOLIDAY 38.55 16.95 8.60 24.15 11.55 8.00

800

840

740

800

840

47.50 30.15

0 0

0 0

30.95 4.80 13.00 7.65 8.90 26.3

64.95 30.55 31.55 20.10 20.25 53.75

0 0 0 44.65 36.55 72.75

60.00 73.00

101.0 130.0

0 0

May /wed/23 May/thu/24 May /fri/25 May /sat/26 May/sun/27 May/mon/28 May/tue/29 May/wed/30 May/thu/31 Jun/fri/01

Jun/sat/02 Jun/sun/03

685.00 690.00 711.00 722.00

692.50 696.85 716.65 724.45

707.05 695.00 697.00 660.00 640.10

704.05 682.90 660.65 634.80 637.10

645.00

673.25

24.70 9.80 8.40 21.55 9.05 0 23.80 8.80 0 22.75 8.00 0 TRADING HOLIDAY 15.95 6.70 0 31.00 77.00 13.00 3.50 1.05 0 0.90 0.75 1.05 0.55 0.20

1.20

0.20

0 0 0 0

0 0 0 0

0 0 0 0

0 0 105.5 0

0 0 0 0

0 0 0 0

0

0

0

0

0

0

0

0

0

0

0

TRADING HOLIDAY Jun/mon/04

681.35

661.45

0.05

0.05

0.05

TABLE DETAILS: 

The first column explains TRADING DATE.



Second Column (a) explains the SPOT MARKET PRICE in cash segment on that date of Opening Balance of Equity Amount.



Second column (b) explains the FUTURE MARKET PRICE in cash segment on that date of Closing Balance on Future Market Amount.



The Third column explains call Option premiums amounting 740, 800, 840.



The Fourth column explains Put Option premiums amounting 740, 800, 840.

OBSERVATIONS & FINDINGS: CALL OPTION:  BUYERS PAY OFF: As brought 1 lot of KOTAK that is 100, those who buy for 740, paid 48.45 premiums per share. Settlement price is 681.35 Spot price Strike price

681.35 740.00

Amount -58.65 Premium paid (-) 48.45 Net Loss -10.20 x 100 = -1020 Buyer Loss = Rs.1020 (Loss) Because it is negative it is in the money contract, hence buyer will get more loss, incase spot price decrease buyer loss also increase.

 SELLERS PAY OFF: It is in the money for the buyer, so it is in out of the money for seller; hence his profit is also increase. Strike price 740.00 Spot price 681.35 Amount +58.65 Premium Received 48.45 Net profit 10.20 x 100 = +1020 Seller Profit = Rs.1020 (Net Amount) Because it is positive it is out of the money, hence seller will get more profit, incase spot price increase in below strike price, seller get loss in premium level

OBSERVATIONS & FINDINGS: PUT OPTION:  BUYERS PAY OFF: Those who have purchase put option at a strike price of 740, the premium payable is 47.50 On the expiry date the spot market price enclosed at 681.35 Strike price Spot price Net pay off

740.00 681.35 58.65 x 100 = 5865

Already, premium paid 48.45, so it can get profit is 5865 Because it is Positive, out of the money contract, hence buyer will get more profit, incase spot price increase buyer get loss in premium level.

 SELLERS PAY OFF: As seller is entitled only for premium so, if he is in profit and also seller has to borne total profit. Spot price Strike price Amount

681.35 740.00 -58.65 x100 =-5865

Already premium received 48.45 so, it can get loss is 5865 Because it is negative, in the money contract, Hence seller gets more loss, incase spot price increase in above strike price seller can get profit in premium level.

ANALYSIS OF FUTURE PRICES:

The Objective of this analysis is to evaluate the profit/loss position futures and options. This analysis is based on sample data taken of M/s. KOTAK STOCK BROCKING LIMITED scrip. This analysis considered the May contract of KOTAK. The lot size of KOTAK is 100, the time period of the analysis is, from 11-05-2012 to 30-06-2012 Table : 5.2 DATE FUTURE PRICE MAY/FRI/11 MAY/SAT/12 MAY/MON/14 MAY /TUE/15 MAY /WED/16 MAY /THU/17 MAY /FRI/18 MAY/SAT/19 MAY/MON/21 MAY /TUE/22 MAY /WED/23 MAY/THU/24 MAY /FRI/25 MAY /SAT/26 MAY/MON/28 MAY/TUE/29 MAY/WED/30 MAY/THU/31 JUN/FRI/01 JUN/SAT/02 JUN/MON/04

738.85 740.20 770.05 822.95 823.15 855.70 848.75 774.55 712.30 685.40 692.50 696.85 716.65 724.45 704.05 682.90 660.65 634.80 637.10 673.25 661.45

Figure : 5.1

FUTURE MARKET: BUYER 11/05/2012(Buying)

738.85

04/06/2012(Cl., period)

SELLER 738.85

681.35 Loss

Profit 100 x57.00=5700, Loss 100 x 57.00=5700

681.35 57.00

Profit

57.00

Because buyer future price will decrease so, he can get loss. Seller future price also decrease so, profit also increase, In case seller future will increase, and he can get loss. The closing price of “Mahindra Satyam” formerly “Satyam Computer services”,at the end of the contract period is 681.35 and this is considered as settlement price.

DATA OF KOTAK – THE FUTURES & OPTIONS OF THE MAY – JUNE MONTH 2012: Table : 5.3 SPOT PRICE

DATE MAY/FRI/11 MAY/SAT/12 MAY/MON/14 MAY /TUE/15 MAY /WED/16 MAY /THU/17 MAY /FRI/18 MAY/SAT/19 MAY/MON/21 MAY /TUE/22 MAY /WED/23 MAY/THU/24 MAY /FRI/25 MAY /SAT/26 MAY/MON/28 MAY/TUE/29 MAY/WED/30 MAY/THU/31 JUN/FRI/01 JUN/SAT/02 JUN/MON/04

FUTURE PRICE

742.00 742.80 780.00 785.00 815.55 848.00 845.00 776.55 767.70 700.00 685.00 690.00 711.00 722.00 707.05 695.00 697.00 660.00 640.10 645.00 681.35

738.85 740.20 770.05 822.95 823.15 855.70 848.75 774.55 712.30 685.40 692.50 696.85 716.65 724.45 704.05 682.90 660.65 634.80 637.10 673.25 661.45

Figure : 5.2

6.CONCLUSIONS OBSERVATIONS AND FINDINGS: 

The future price of M/S KOTAK STOCK moving along with the market price.



If the buy price of the future is less than the settlement price, than the buyer gets profit on futures.



If the selling price of the future is less than the settlement price, than the seller incur losses.

SUGGESTIONS: 

In bullish market the call option writer incurs more losses so the investor is suggested to go for a call option to hold, where as the put option holder suffers in a bullish market, so he is suggested to write a put option.



In bearish market the call option holder will incur more losses so the investor is suggested to go for a call option to write, where as the put option writer will get more losses, so he is suggested to hold a put option.



In the above analysis the market price of M/S.KOTAK is having low volatility, so the call option writers enjoy more profits to holders.



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.

CONCLUSIONS: 

Derivatives market is an innovation to cash market. Approximately its daily turnover reaches to the equal stage of cash market. The average daily turnover of the NSE derivative segments



In cash market the profit/loss of the investor depends on the market price of the underlying asset. The investor may incur huge profits or he may incur huge loss. 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 writer is purely depend on the fluctuations of the underlying asset.

BIBLIOGRAPHY:

 BOOKS:   

Derivatives Dealers Module Work book–NCFM Financial Markets and Services–GORDAN and NATRAJAN Financial Management – PRASANNA CHANDRA

 JOURNALS:  

The journal of derivatives. International journal of financial markets & derivatives.

 NEWS PAPERS:   

Economic times The Hindu Business Standard

 MAGAZINES:   

Business Today Business World Business India

 WEBSITES:      

www.derivativesindia.com www.indianinfoline.com www.nseindia.com www.bseindia.com www.sebi.gov.in www.google.com

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