Lohith Final Report(2).doc

A Study On DERIVATIES SUBMITTED TO

INSTITUTE OF PUBLIC ENTERPRISE Survey No. 1266, Shamirpet (V&M), R.R.Dist, Hyderabad, Telangana 500078 (2016– 2018) In partial fulfillment of the requirements For the award of the Degree of POST GRADUATE DIPLOMA IN MANAGEMENT

BY MANDADI LOHITH REDDY (1601064) Under the esteemed guidance of V.ANJI RAJU ASSOCIATE PROFESSOR MARKETING

Signature of mentor

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CERTIFICATE This is to certify that the research project titled ―A Study on Derivatives‖, submitted in partial fulfillment of PGDM programme by Mr. M.Lohith Reddy (R.No 1601064) under my guidance. This has not been submitted to any other university or institution for the award of any degree/diploma/certificate.

Signature of the Mentor V.Anji Raju

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DECLARATION I hereby declare that this Project Report titled, “A REPORT ON DERIVATIES” submitted by me to Institute of Public Enterprise, Shamirpet Campus, Hyderabad – 500 078, is a bonafide work undertaken by me and it is not submitted to any other University or Institutions for the award of any degree or diploma/certificate or published any time before.

M.LOHITH REDDY PGDM-1601064 DATE:

Signature of student

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ACKNOWLEDGEMENT With great pleasure, I want to take this opportunity to express my heart full gratitude to all the people who helped this main project a grand success. With immense pleasure, I wish to express my deep sense of gratitude to my mentor V.Anji Raju(Associate Professor) for his guidance during all stages of this project and for helping me throughout the project in spite of their busy schedule and also for their ceaseless patience. His opinions and experiences offered me valuable insights into the study area and enhanced the value of the project.

I would like to thank Dr. R. K. Mishra, Director, Institute of Public Enterprise, Hyderabad, Dr. NarendranathMenon , PGDM coordinator and having permitted me to carry out this project work. Lastly I would like to thank my faculty an my friends for their support and cooperation and without their support and guidance I would have not been able to complete the project.

M.LOHITH REDDY

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Table of Contents INTRODUCTION.....................................................................................................................................6 Need for study……………………………………………………………………………………………8 Objectives of the study………………………………………………………………9 Importance of the study………………………………………………………………9

REVIEW OF LITERATURE.............................................................................................................11 DERIVATIVES..........................................................................................................................................14 Participants in the derivatives market………………………………………………17 Types of derivatives…………………………………………………………………...20 Uses of Derivatives…………………………………………………………………....27

DATA ANALYSIS & INTERPRETATION...............................................................................28

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Chapter 1

INTRODUCTION

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INTRODUCTION:Derivatives have vital role to play in enhancing shareholder value by ensuring access to the cheapest source of funds. Active use of derivatives instruments allows the overall business risk profile to be modified, thereby providing the potential to improve earning quality by offsetting undesired risk. The appearance of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset Prices. As instruments of risk management, these generally do not influence the Fluctuations in the underlying asset prices. However, by locking-in asset prices, Derivative products minimize the impact of fluctuations in asset prices on the Profitability and cash flow situation of risk-averse investors. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, Currency, interest, etc., Banks, Securities firms, companies and investors to hedge risks, to gain access to cheaper money and to make profit, use derivatives. Derivatives are likely to grow even at a faster rate in future. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset Prices. As instruments of risk management, these generally do not influence the Fluctuations in the underlying asset prices. However, by locking-in asset prices, Derivative products minimize the impact of fluctuations in asset prices on the Profitability and cash flow situation of risk-averse investors.

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NEED FOR THE STUDY:Different investment avenues are available for the investors. The investor should compare the risk and expected yields after adjustment of tax on various instruments. While taking an investment decision the investor may search for advice from an expert and consultancy including stock brokers and analysts. The objective here is to make the investor aware of the functioning of the derivatives. Derivatives act as a risk hedging tool for the investors. The objective is to help the investor in selecting the appropriate derivatives instrument to attain the maximum return and to construct the portfolio in such a manner to meet the investor needs and to decide how best to reach the goals from the available derivative of a certain company. To identify the investor objective constraints and performance, which help formulate the investment in trading. To develop and improve the strategies in the investment in share options. Stockbrokers will help in the selection of asset classes and securities in each class depending upon their risk and return attributes.

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OBJECTIVES OF THE STUDY:To study various trends in derivatives market. Comparison of the profit/losses in a cash market and derivative market. To know different types of derivatives instruments. To analyze the derivatives market in India. To analyze the operations of futures and options. To find the profit/loss position of futures buyer and seller the option writer and option holder. To study about risk management with the help of derivatives.

IMPORTANCE OF THE STUDY:The project covers the derivatives market and its instruments. For better understandings various strategies with different situations and actions have been given. it includes the data collected in the recent years and also the market in derivatives in the recent years . This study extends to the trading of derivatives done in national stock exchange.

SCOPE OF THE STUDY:Derivatives deals with derivatives, equity and mutual funds etc., In this we are finding which one is the best and analyze the customer awareness in derivatives market and it also covers the recent changes in derivatives market. It gives the information about forwards, futures, options and swaps. It concentrates on how securities are traded in derivative markets.

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METHODOLOGY:The data collection of the study consists of secondary data. Secondary data The company‘s annual records Company manuals and magazines Web sites. Financial management text books. Printed materials. Journals & magazines. News papers. Text books. Company maintained reports.

LIMITATIONS OF THE STUDY:In spite of honest and sincere efforts, there are certain discrepancies and inconsistencies. The limitations are. The study is restricted to limited period The firm refused to disclose some confidential information The study was conducted with the data available and the analysis was made accordingly. It is restricted to Hyderabad only. it is carried for a short period of 2 months and hence the findings of the study cannot be generalized.

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CHAPTER 2

REVIEW OF LITERATURE

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ARTICLES REVIEW 1: A New Model for Pricing Collateralized Financial Derivatives. AUTHOR: Tim Xiao (Tim Xiao is a senior director of risk models and capital markets at BMO in Toronto, Canada) In recent years, collateralization of derivative contracts has extended from the standard mark-to-market and margining systems for exchange-traded contracts to the over-the-counter (OTC) market. This expansion of credit enhancement in OTC contracts has been underway at least since the 1990s, but it was formalized in the Dodd–Frank Act. The great majority of derivatives are now subject to collateralization requirements that are specified in a Credit Support Annex to the counterparties‘ ISDA agreement. Derivatives counterparties must make a credit value adjustment (CVA) to the value of a contract on their books to account for the effect of counterparty credit risk. But the pricing models generally do not take the interaction between market prices and collateral values into account. This article develops a valuation approach that incorporates the counterparty‘s credit quality and the effect of collateral, given market practices on how collateral is handled both under normal conditions and in a bankruptcy. Empirical comparison of the pricing of matched swaps with and without collateral support shows that the market does adjust for the mitigation of counterparty risk by the use of collateral, and that both factors are important.

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REVIEW 2: Is the Derivatives Business Too Big? AUTHOR: Alan White While acknowledging the theoretical and practical importance of derivatives pricing models, White is puzzled by the tremendous amount of trading, especially within the financial sector (rather than between financial intermediaries and end-users) in zero-sum instruments that are supposed to be redundant. One possible explanation is that because risk exposure and the ―fair‖ return on a derivative are conceptually hard to pin down, many derivatives investors may not be assessing risk exposures correctly. If so, better risk measures should lead to less trading in derivatives markets.

REVIEW 3: Derivatives within Frontier Markets AUTHOR: Ronald T. Slivka and Jiayun Zhang The objective of this study is to develop a practical comprehensive survey of derivatives presently trading within frontier markets for use by money managers and hedgers, assessing the array of derivatives types and their uses. A literature search reveals that no frontier market survey of this kind currently exists. In this study, exchangetraded and over-the-counter (OTC) derivatives include the following instruments: futures, forwards, swaps, options, and contracts for differences. The survey also includes ETFs. Where data exist, the survey provides information on the location and availability of frontier market derivatives contract descriptions and price and volume data. Such information on derivatives is of increasing practical value and convenience to both investors and hedgers transacting in today‘s frontier markets.

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Chapter 3

DERIVATIVES

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DERIVATIVES MEANING: The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, currency, interest etc. Annual turnover of the derivatives is increasing each year from 1986 onwards.

Derivatives are used by banks, securities firms, companies and investors to hedge risks, to gain access to cheaper money and to make profits Derivatives are likely to grow even at a faster rate in future they are first of all cheaper to world have met the increasing volume of products tailored to the needs of particular customers, trading in derivatives has increased even in the over the counter markets. In Britain unit trusts allowed to invest in futures & options .The capital adequacy norms for banks in the European Economic Community demand less capital to hedge or speculate through derivatives than to carry underlying assets. Derivatives are weighted lightly than other assets that appear on bank balance sheets. The size of these off-balance sheet assets that include derivatives

is more than seven times as large as balance sheet items at some American banks causing concern to regulators.

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DEFINITION Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines ―derivative‖ to includeA security derived from a debt instrument, share, and loan whether secured or unsecured, risk instrument or contract for differences or any other form of security.

A contract, which derives its value from the prices, or index of prices, of underlying securities. Derivatives are the securities under the SC(R)A and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A. The Securities Contracts (Regulation) Act, 1956 defines "derivatives" to include: A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument, or contract for differences or any other form of security. A contract which derives its value from the prices, or index of prices, of underlying securities. At present, the equity derivatives market is the most active derivatives market in India. Trading volumes in equity derivatives are, on an average, more than three and a half times the trading volumes in the cash equity markets. Two important terms Before discussing derivatives, it would be useful to be familiar with two terminologies relating to the underlying markets. These are as follows: 1. Spot Market In the context of securities, the spot market or cash market is a securities market in which securities are sold for cash and delivered immediately. The delivery happens after the settlement period. Let us describe this in the context of India. The NSE‘s cash market segment is known as the Capital Market (CM) Segment. In this market, shares of SBI, Reliance, Infosys, ICICI Bank, and other public listed companies are traded. The settlement period in this market is on a T+2 basis i.e., the buyer of the shares receives the shares two working days after trade date and the seller of the shares receives the money two working days after the trade date. 16 | P a g e

2. Index Stock prices fluctuate continuously during any given period. Prices of some stocks might move up while that of others may move down. In such a situation, what can we say about the stock market as a whole? Has the market moved up or has it moved down during a given period .Similarly, have stocks of a particular sector moved up or down? To identify the general trend in the market (or any given sector of the market such as banking), it is important to have a reference barometer which can be monitored. Market participants use various indices for this purpose. An index is a basket of identified stocks, and its value is computed by taking the weighted average of the prices of the constituent stocks of the index. A market index for example consists of a group of top stocks traded in the market and its value changes as the prices of its constituent stocks change. In India, Nifty Index is the most popular stock index and it is based on the top 50 stocks traded in the market. Just as derivatives on stocks are called stock derivatives, derivatives on indices such as Nifty are called index derivatives.

PARTICIPANTS IN THE DERIVATIVES MARKET The following three broad categories of participants who trade in the derivatives market: Hedgers Speculators and Arbitrageurs Hedgers: Hedgers face risk associated with the price of an asset. They use futures or options markets to reduce or eliminate this risk. Speculators: Speculators wish to bet on future movements in the price of an asset. Futures and Options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture.

Arbitrageurs: Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. 17 | P a g e

FUNCTIONS OF THE DERIVATIVES MARKET: The derivatives market performs a number of economic functions. They are: 1. Prices in an organized derivatives market reflect the perception of market participants about the future and lead the prices of underlying to the perceived future level.

2. Derivatives, due to their inherent nature, are linked to the underlying cash markets. With the introduction of derivatives, the underlying market witnesses higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk. 3. Speculative trades shift to a more controlled environment of derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets. 4. An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity. 5. Derivatives markets help increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity. Terminology of Derivatives. 1 .Spot price (ST) Spot price of an underlying asset is the price that is quoted for immediate delivery of the asset. For example, at the NSE, the spot price of Reliance Ltd. at any given time is the price at which Reliance Ltd. shares are being traded at that time in the Cash Market Segment of the NSE. Spot price is also referred to as cash price sometimes. 2 .Forward price or futures price (F) Forward price or futures price is the price that is agreed upon at the date of the contract for the delivery of an asset at a specific future date. These prices are dependent on the spot price, the prevailing interest rate and the expiry date of the contract.

3. Strike price (K) The price at which the buyer of an option can buy the stock (in the case of a call option) or sell the stock (in the case of a put option) on or before the expiry date of option contracts is called strike price. It is the price at which the stock will be bought or sold when the option is exercised. Strike price is used in the case of options only; it is not used for futures or forwards. 4. Expiration date (T) In the case of Futures, Forwards, Index and Stock Options, Expiration Date is the date on which settlement takes place. It is also called the final settlement date. 18 | P a g e

5. Premium: Premium is the amount paid by the holder of an Option for the right he gets to exercise the Option. Premium of an Option can be separated into two components –Intrinsic Value and Time Value 6. Intrinsic Value: Intrinsic Value of an Option is the amount which would be credited to holder of an Option if he were to exercise the Option and close out the position. A Call will have intrinsic value if exercise price is less than the current market price of the Underlying. Intrinsic value is equal to Current Market price – Exercise Price. A Put will have intrinsic value if the exercise price is more than the current market price of the underlying.(i.e.) Exercise Price – Current Market Price. 6. Time Value: Additional amount of premium over and above the intrinsic value is the time value or extrinsic value of Option. At the Money and Out of Money Options will only have Time Value and no intrinsic value. 7. In the money An Option with intrinsic value is said to be in-the-money. In order to be in the money call should have exercise price less than the current market price and Put should have exercise price more than Current market price. 8. At the money: An Option whose exercise price is equal to current market price is said to be at the money. 9. Out of the money: A call option is said to be Out of money if the exercise price is more than the current market price of the Underlying. Put Option is said to be Out of money if exercise price is less than the current market price of underlying

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TYPES OF DERIVATIVES The most commonly used derivatives contracts are forwards, futures and options. Here various derivatives contracts that have come to be used are given briefly: 1. Forwards 2. Futures 3. Options Forwards A forward contract or simply a forward is a contract between two parties to buy or sell an asset at a certain future date for a certain price that is pre-decided on the date of the contract. The future date is referred to as expiry date and the pre-decided price is referred to as Forward Price. It may be noted that Forwards are private contracts and their terms are determined by the parties involved. A forward is thus an agreement between two parties in which one party, the buyer, enters in to an agreement with the other party, the seller that he would buy from the seller an underlying asset on the expiry date at the forward price. Therefore, it is a commitment by both the parties to engage in a transaction at a later date with the price set in advance. This is different from a spot market contract, which involves immediate payment and immediate transfer of asset.

The basic features of a contract are given in brief here as under: 1. Forward contracts are bilateral contracts, and hence, they are exposed to the counter party risk. There is risk of non-performance of obligation either of the parties, so these are riskier than to futures contracts. 2. Each contract is custom designed, and hence, is unique in terms of contract size, expiration date, the asset type, quality etc. 3. In forward contract, one of the parties takes a long position by agreeing to buy the asset at a certain specified future date. The other party assumes a short position by agreeing to sell the same asset at the same date for the same specified price. A party with no obligation offsetting the forward contract is said to have an open position. A party with a close position is, sometimes, called a hedger. 20 | P a g e

4. The specified price in a forward contract is referred to as the delivery price. The forward price for a particular forward contract at a particular time is the delivery price that would apply if the contract were entered into at that time. It is important to differentiate between the forward price and the delivery price. Both are equal at the time the contact is entered into. However, as time passes, the forward price is likely to change whereas the delivery price remains the same. 5. In the forward contract, derivative asset can often be contracted from the combination of underlying assets; such assets are often known as synthetic assets in the forward market. Settlement of forward contracts When a forward contract expires, there are two alternate arrangements possible to settle the obligation of the parties: physical settlement and cash settlement. Both types of settlements happen on the expiry date and are given below. Physical Settlement A forward contract can be settled by the physical delivery of the underlying asset by a short investor (i.e. the seller) to the long investor (i.e. the buyer) and the payment of the agreed forward price by the buyer to the seller on the agreed settlement date.

Cash settlement Cash settlement does not involve actual delivery or receipt of the security. Each party either pays (receives) cash equal to the net loss (profit) arising out of their respective position in the contract. So, where the spot price at the expiry date (ST) was greater than the forward price (FT), the party with the short position will have to pay an amount equivalent to the net loss to the party at the long position. Please note that the profit and loss position in case of physical settlement and cash settlement is the same except for the transaction costs which is involved in the physical settlement. Futures Like a forward contract, a futures contract is an agreement between two parties in which the buyer agrees to buy an underlying asset from the seller, at a future date at a price that is agreed upon today. However, unlike a forward contract, a futures contract is not a private transaction but gets traded on a recognized stock exchange. In addition, a futures contract is standardized by the exchange. All the terms, other than the price, are set by the

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stock exchange (rather than by individual parties as in the case of a forward contract). Also, both buyer and seller of the futures contracts are protected against the counter party risk by an entity called the Clearing Corporation. The Clearing Corporation provides this guarantee to ensure that the buyer or the seller of a futures contract does not suffer as a result of the counter party defaulting on its obligation. In case one of the parties defaults, the Clearing Corporation steps in to fulfil the obligation of this party, so that the other party does not suffer due to non-fulfilment of the contract. To be able to guarantee the fulfilment of the obligations under the contract, the Clearing Corporation holds an amount as a security from both the parties. This amount is called the Margin money and can be in the form of cash or other financial assets. Also, since the futures contracts are traded on the stock exchanges, the parties have the flexibility of closing out the contract prior to the maturity by squaring off the transactions in the market. The party that agrees to buy the asset on a future date is referred to as a long investor and is said to have a long position. Similarly the party that agrees to sell the asset ina future date is referred to as a short investor and is said to have a short position. The price agreed upon is called the delivery price or the Forward Price. Forward contracts are traded only in Over the Counter (OTC) market and not in stock exchanges. OTC market is a private market where individuals/institutions can trade through negotiations on a one to one basis.

The features of a futures contract may be specified as follows: 1. Futures are traded only in organized exchanges. 2. Futures contract required to have standard contract terms. 3. Futures exchange has associated with clearing house. 4. Futures trading required margin payment and daily settlement. 5. Futures positions can be closed easily. 6. Futures markets are regulated by regulatory authorities like SEBI. 7. The futures contracts are executed on expiry date. 8. The futures prices are expressed in currency units, with a minimum price movement calle a tick size. The quality of positive economic theory explains about its ability with precision clarity and simplicity.

Types of futures There are different types of contracts in financial futures which are traded in the various futures market of the world. The followings are the important types of financial futures contract: 1. Stock future or equity futures 2. Stock index futures 3. Currency futures 22 | P a g e

4. Interest rate futures

OPTIONS An option is a derivative contract between a buyer and a seller, where one party (say First Party) gives to the other (say Second Party) the right, but not the obligation, to buy from (or sell to) the First Party the underlying asset on or before a specific day at an agreed-upon price. In return for granting the option, the party granting the option collects a payment from the other party. This payment collected is called the ―premium‖ or price of the option. The right to buy or sell is held by the ―option buyer‖ (also called the option holder); the party granting the right is the ―option seller‖ or ―option writer‖. Unlike forwards and futures contracts, options require a cash payment (called the premium) upfront from the option buyer to the option seller. This payment is called option premium or option price. Options can be traded either on the stock exchange or in over the counter (OTC) markets. Options traded on the exchanges are backed by the Clearing Corporation thereby minimizing the risk arising due to default by the counter parties involved. Options traded in the OTC market however are not backed by the Clearing Corporation. There are two types of options —call options and put options—which are explained below.

1 .Call option A call option is an option granting the right to the buyer of the option to buy the underlying asset on a specific day at an agreed upon price, but not the obligation to do so. It is the seller who grants this right to the buyer of the option. It may be noted that the person who has the right to buy the underlying asset is known as the ―buyer of the call option‖. The price at which the buyer has the right to buy the asset is agreed upon at the time of entering the contract. This price is known as the strike price of the contract (call option strike price in this case). Since the buyer of the call option has the right (but no obligation) to buy the underlying asset, he will exercise his right to buy the underlying asset if and only if the price of the underlying asset in the market is more than the strike price on or before the expiry date of the contract. The buyer of the call option does not have an obligation to buy if he does not want to. 2. Put option

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A put option is a contract granting the right to the buyer of the option to sell the underlying asset on or before a specific day at an agreed upon price, but not the obligation to do so. It is the seller who grants this right to the buyer of the option. The person who has the right to sell the underlying asset is known as the ―buyer of the put option‖. The price at which the buyer has the right to sell the asset is agreed upon at the time of entering the contract. This price is known as the strike price of the contract (put option strike price in this case). Since the buyer of the put option has the right (but not the obligation) to sell the underlying asset, he will exercise his right to sell the underlying asset if and only if the price of the underlying asset in the market is less than the strike price on or before the expiry date of the contract. The buyer of the put option does not have the obligation to sell if he does not want to. The main characteristics of options are following: 1. Options holders do not receive any dividend or interest. 2. Option yield only capital gains. 3. Options holder can enjoy a tax advantages. 4. Options are traded on OTC and in all recognized stock exchanges. 5. Options holders can control their rights on the underlying assets. 6. Options create the possibility of gaining a windfall profit. 7. Options holder can enjoy a much wider risk- return combinations. 8. Options can reduce the total portfolio transaction costs. 9. Options enable with the investors to gain a better returns with a limited amount of investment. Types of options Options can be divided into two different categories depending upon the primary exercise styles associated with options. These categories are: European Options: These are options that can be exercised only on the expiration date. American options: These are options that can be exercised on any day on or before the expiry date. They can be exercised by the buyer on any day on or before the final settlement date or the expiry date. Position in Option: Long Position in Call Option - Bullish. Short Position in Call Option -Bearish. Long Position in Put Option -Bearish. 24 | P a g e

Short Position in Put Option -Bullish. Contract size As futures and options are standardized contracts traded on an exchange, they have a fixed contract size. One contract of a derivatives instrument represents a certain number of shares of the underlying asset. For example, if one contract of BHEL consists of 300 shares of BHEL, then if one buys one futures contract of BHEL, then for every Re 1 increase in BHEL‘s futures price, the buyer will make a profit of 300 X 1 = Rs 300 and for every Re 1 fall in BHEL‘s futures price, he will lose Rs 300. Contract Value Contract value is notional value of the transaction in case one contract is bought or sold. It is the contract size multiplied but the price of the futures. Contract value is used to calculate margins etc. for contracts. In the example above if BHEL futures are trading at Rs. 2000 the contract value would be Rs. 2000 x 300 = Rs. 6 lakhs. Uses of Derivatives 1. Risk management The most important purpose of the derivatives market is risk management. Risk management for an investor comprises of the following three processes: o Identifying the desired level of risk that the investor is willing to take on his investments; o Identifying and measuring the actual level of risk that the investor is carrying; and o

Making arrangements which may include trading (buying/selling) of derivatives contracts that allow him to match the actual and desired levels of risk.

2. Market efficiency Efficient markets are fair and competitive and do not allow an investor to make risk free profits. Derivatives assist in improving the efficiency of the markets, by providing a self-correcting mechanism. Risk free profits are not easy to make in more efficient markets. When trading occurs, there is a possibility that some amount of mispricing might occur in the markets. The arbitrageurs step in to take advantage of this mispricing by buying from the cheaper market and selling in the higher market. Their actions quickly narrow the prices and thereby reducing the inefficiencies. 3. Price discovery One of the primary functions of derivatives markets is price discovery. They provide valuable information about the prices and expected price fluctuations of the underlying assets in two ways: 25 | P a g e

First, many of these assets are traded in markets in different geographical locations. Because of this, assets may be traded at different prices in different markets. In derivatives markets, the price of the contract often serves as a proxy for the price of the underlying asset. For example, gold may trade at different prices in Mumbai and Delhi but a derivatives contract on gold would have one value and so traders in Mumbai and Delhi can validate the prices of spot markets in their respective location to see if it is cheap or expensive and trade accordingly. Second, the prices of the futures contracts serve as prices that can be used to get a sense of the market expectation of future prices. For example, say there is a company that produces sugar and expects that the production of sugar will take two months from today. As sugar prices fluctuate daily, the company does not know if after two months the price of sugar will be higher or lower than it is today. How does it predict where the

price of sugar will be in future? It can do this by monitoring prices of derivatives contract on sugar (say a Sugar Forward contract). If the forward price of sugar is trading higher than the spot price that means that the market is expecting the sugar spot price to go up in future. If there were no derivatives price, it would have to wait for two months before knowing the market price of sugar on that day. Based on derivatives price the management of the sugar company can make strategic and tactical decisions of how much sugar to produce and when. Intrinsic value of an option: Intrinsic value of an option at a given time is the amount the holder of the option will get if he exercises the option at that time. In other words, the intrinsic value of an option is the amount the option is in-the-money (ITM). If the option is out-of the- money (OTM), its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max [0, (St — K)] which means that the intrinsic value of a call is the greater of 0 or (St — K). Similarly, the intrinsic value of a put is Max [0, K — St] i.e., the greater of 0 or (K — S t) where K is the strike price and S t is the spot price. Time value of an option: In addition to the intrinsic value, the seller charges a ‗time value‘ from the buyers of the option. This is because the more time there is for the contract to expire, the greater the chance that the exercise of the contract will become more profitable for the buyer. This is a risk for the seller and he seeks compensation for it by demanding a ‗time value‘. The time value of an option can be obtained by taking the difference between its premium and

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its intrinsic value. Both calls and puts have time value. An option that is Out-of-the-money (OTM) or At-the-money (ATM) has only time value and no intrinsic value. Usually, the Maximum time value exists when the option is ATM. The longer the time to expiration, the Greater is an option‘s time value, all else being equal. At expiration, an option has no time Value. Factors impacting option prices The supply and demand of options and hence their prices are influenced by the following factors: o o o o o

The underlying price, The strike price, The time to expiration, The underlying asset‘s volatility, and Risk free rate.

Equities Derivatives: Equity derivative is a class of derivatives whose value is at least partly derived from one or more underlying equity securities. Options and futures are by far the most common equity derivatives. This section provides you with an insight into the daily activities of the equity derivatives market segment on NSE. 2 major products under Equity derivatives are Futures and Options, which are available on Indices and Stocks. Product

No. of contracts

Turnover(cr)

Index futures Stock futures Index options Stock options F & O total

2,39,614 7,82,354 53,43,132 6,35,924 70,01,024

19,456.88 57,083.17 4,51,356.49 48,007.91 5,75,904.46

Premium turnover 1,679.54 622.21 2301.75

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CHAPTER 4

DATA ANALYSIS & INTERPRETATION

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Reliance communications:Profile Reliance Communications Limited is the flagship Company of Reliance Group, one of the leading business houses in India. Reliance Communications is India‘s foremost and truly integrated telecommunications service provider. The Company has a customer base of over 111 million including over 2.6 million individual overseas retail customers. Reliance Communications corporate clientele includes over 39,000 Indian and multinational corporations including small and medium enterprises and over 290 global, regional and domestic carriers. Reliance Communications has established a pan-India, next generation, integrated (wireless and wire line), convergent (voice, data and video) digital network that is capable of supporting best-of-class services spanning the entire communications value chain, covering over 21,000 cities and towns and over 400,000 villages. Reliance Communications owns and operates the world‘s largest next generation IP enabled connectivity infrastructure, comprising over 280,000 kilometres of fibre optic cable systems in India, USA, Europe, Middle East and the Asia Pacific region.     

Total turnover- 10295.00 cr Net income-(1624 cr) Total assets – Rs 60,449.00 cr Total equity- Rs 1,244.00 cr Total employees-8,708 employees as on March 31, 2017.

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Reliance equity and futures Date

Market price

Future price

28-july-17

25.6

26.7

27-july-17

26

25.95

26-july-17

26

26

25-july 17

25.1

25.8

24-july-17

24.6

25

21-july-17

24.5

24.55

20-july-17

24.8

24.7

19-july-17

24

25

17-july-17

24.5

23.9

17-july-17

24.55

24.6

14-july-17

24

24.55

13-july-17

24.55

24.15

12-july-17

24.7

24.55

11-july-17

24.5

24.15

10-july-17

23.3

24.45

07-july-17

22.45

23.05

06-july-17

22.1

22.7

05-july-17

21.55

22.1

04-july-17

22.1

21.15

03-july-17

21.6

22.2

30-june-17

22.1

21.6

The following table explains the market price and premium of calls. The first column explains trading date Second column explains SPOT market price in cash segment on that date. The third column explains future prices

OBSERVATIONS AND INTERPRETATION: If a person buys 1 lot i.e., 14000 futures of reliance communications on 30 June 2017 and sells on 28 July 2017 then he will get a loss of 22.1-25.6 =3.5 per share. so he will get a loss of 49000 i.e.3.5*14000 If he sells on 26th July, 2017 then he will get a profit of 26-25.6 =0.4 i.e. a profit of 0.4 per share. So his total profit is 5600 i.e., 0.4*14000 The closing price of reliance communications at the end of the contract period is 25.6 and this I considered as settlement price 30 | P a g e

RELIANCE PUT OPTION

STRIKE Date

MARKET Price

22.5

25

27.5

30

40

28-Jul-17

26.7

0.3

0.85

2

4.15

13.35

27-Jul-17

25.95

0.45

1.15

2.75

4.5

13.85

26-Jul-17

26

0.45

1.15

2.6

4.5

14.1

25-Jul-17

25.8

0.55

1.3

2.6

4.85

14.25

24-Jul-17

25

0.75

1.75

3.65

5.6

15

21-Jul-17

24.55

0.8

1.8

4.05

6.05

15.5

20-Jul-17

24.7

0.95

1.85

4

5.95

15.3

19-Jul-17

25

0.75

1.6

3.45

5.8

15

17-Jul-17

23.9

1.2

2.4

4.55

6.6

16.05

17-Jul-17

24.6

1.35

2.55

4.15

6.1

15.4

14-Jul-17

24.55

1.45

2.7

4.35

6.25

15.45

13-Jul-17

24.15

1.65

2.95

4.65

6.6

15.8

12-Jul-17

24.55

1.65

2.9

4.05

6.4

15.5

11-Jul-17

24.45

1.75

2.1

3.8

6.55

15.6

10-Jul-17

24.55

0.6

3.05

4.65

6.55

15.45

07-Jul-17

23.05

2.3

3.8

5.6

7.6

16.9

06-Jul-17

22.7

2.55

4.05

5.9

7.95

17.25

05-Jul-17

22.1

2.9

4.5

6.4

8.5

17.9

04-Jul-17

21.15

3.35

5.05

7.05

9.2

17.7

03-Jul-17

22.2

2.9

4.5

6.4

8.5

17.85

21.75

3.2

4.85

6.75

8.4

17.2

30-Jun-17

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OBSERVATIONS AND INTERPRETATION PUT OPTION BUYERS PAY OFF: If a person brought 1 lot of reliance communications that is 14000, those who buy for 27.5 paid 6.75 premiums per share. Settlement price is 26.7 Strike price = 27.5 Spot Price = 26.7 0.8 Premium (-) 6.75 (5.95) Buyers loss = Rs 83300 i.e. (5.95)*14000 Because it is negative it is out of the money contract hence buyer will get more loss, In case spot price decreases, buyer‘s profit will increase. SELLERS PAYOFF: It is in the money for the buyer so it is in the money for then seller, hence he is in profits. The profit is equal to the loss of buyer i.e. 83300 OBSERVATIONS AND INTERPRETATIONS The future price of reliance communications is moving along with the market price. If the buy price of the future is less than the settlement price, than the buyer of

a future gets profit. If the selling price of the future is less than the settlement price, than the Seller incur losses.

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Reliance call option

Strike price

Date

MARKET

22.5

25

27.5

30

40

PRICE 28-Jul-17

26.7

4.75

2.45

1.2

0.5

0.05

27-Jul-17

25.95

3.65

2.1

1.15

0.55

0.05

26-Jul-17

26

3.85

2.1

1.2

0.7

0.05

25-Jul-17

25.8

3.9

2.05

1.15

0.7

0.05

24-Jul-17

25

3.2

1.75

0.8

0.5

0.05

21-Jul-17

24.55

2.8

1.5

0.7

0.35

0.05

20-Jul-17

24.7

2.95

1.55

0.7

0.5

0.05

19-Jul-17

25

3.6

1.6

0.85

0.45

0.05

17-Jul-17

23.9

2.85

1.6

0.9

0.55

0.05

17-Jul-17

24.6

3.35

1.95

1.25

0.7

0.05

14-Jul-17

24.55

2.95

1.8

0.7

0.8

0.1

13-Jul-17

24.15

3.3

1.7

0.8

0.8

0.1

12-Jul-17

24.55

3.65

1.95

1.1

0.95

0.15

11-Jul-17

24.45

3.65

2.3

0.95

0.75

0.15

10-Jul-17

24.55

3.75

2.65

0.95

1.15

0.2

07-Jul-17

23.05

2.6

1.85

1.15

0.7

0.1

06-Jul-17

22.7

2.35

1.75

1.15

0.7

0.1

05-Jul-17

22.1

1.75

1.55

1

0.6

0.1

04-Jul-17

21.15

2

1

0.8

0.5

0.1

03-Jul-17

22.2

2.5

1.6

1.05

0.65

0.1

30-Jun-17

21.6

2.45

1.6

1.05

0.6

0.1

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OBSERVATIONS AND INTERPRETATION: CALL OPTION BUYERS PAY OFF: Those who have purchased call option at a strike price of 27.5, the premium payable is 1.05 On the expiry date the spot market price enclosed at 26.7. As it is out of the money for the buyer and in the money for the seller, hence the buyer is in loss. So the buyer will lose only i.e. 39.65 premiums i.e. 39.65 per share. So the total loss will be 1.05*14000= Rs14700 SELLERS PAY OFF: As seller is entitled only for premium if he is in profit. So his profit is only premium i.e. 1.05*14000= Rs14700

IDBI bank Industrial Development Bank of India Industrial Development bank of India (IDBI) was constituted under Industrial Development bank of India Act, 1964 as a Development Financial Institution and came into being as on July 01, 1964 vide GOI notification dated June 22, 1964. It was regarded as a Public Financial Institution in terms of the provisions of Section 4A of the Companies Act, 1956. It continued to serve as a DFI for 40 years till the year 2004 when it was transformed into a Bank. Change of name of IDBI Ltd. to IDBI Bank Ltd. In order that the name of the Bank truly reflects the functions it is carrying on, the name of the Bank was changed to IDBI Bank Limited and the new name became effective from May 07, 2008 upon issue of the Fresh Certificate of Incorporation by Registrar of Companies, Maharashtra. The Bank has been accordingly functioning in its present name of IDBI Bank Limited.

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As on March 31 Capital Reserves & Surplus Deposits Borrowings Other Liabilities & Provisions Total Liabilities Cash & Balances with RBI Balances with Banks & Money at Call & Short Notice Investments Advances Fixed & Other Assets Total Assets Total Income

2017 2,058.81 20,504.83 2,68,538.10 56,363.98 14,302.17 3,61,767.90 13,346.92 19,33716 92,934.41 1,90,825.93 45,323.48 3,61,767.90 31,758.97

IDBI EQUITY AND FUTURES Date

MARKET PRICE

FUTUREPRICE

28-Jul-17

59

59.7

27-Jul-17

63.15

59.9

26-Jul-17

62.1

62.85

25-Jul-17

61.5

62.3

24-Jul-17

59.7

61.15

21-Jul-17

58.8

59.65

20-Jul-17

58.3

59

19-Jul-17

58.55

58.5

17-Jul-17

58

58.2

17-Jul-17

57.45

58.35

14-Jul-17

56.95

57.45

13-Jul-17

57.55

57.25

12-Jul-17

56.8

57.55

11-Jul-17

58.6

56.55

10-Jul-17

57.45

58.4

07-Jul-17

57.4

56.45

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06-Jul-17

55.9

57.6

05-Jul-17

53.85

55.7

04-Jul-17

54.1

53.65

03-Jul-17

53.8

54.25

30-Jun-17

53.5

53.9

The following table explains the market price and premium of calls. The first column explains trading date Second column explains SPOT market price in cash segment on that date. The third column explains future price.

OBSERVATIONS AND INTERPRETATION: If a person buys 1 lot i.e., 2100 futures of IDBI on 30-june-2017 and sells on 28 July 2017 then he will get a loss of 53.5-59=(5.5) per share. so he will get a loss of 11550 i.e. 5.5*2100 If he sells on 17th July, 2017 then he will get a profit of 4.05 i.e. a profit of 57.45-53.5 =3.95 per share. So his total profit is 8295 i.e., 3.95*2100 .The closing price of IDBI at the end of the contract period is 59 and this I considered as settlement pric

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IDBI CALL OPTION

STRIKE PRICE

Date

FUTUREPRICE

50

57.5

60

62.5

70

28-Jul-17

59.7

9.8

3.7

2.4

1.6

0.4

27-Jul-17

59.9

10.05

4.3

2.65

1.7

0.45

26-Jul-17

62.85

12.6

6.25

4.2

2.9

0.65

25-Jul-17

62.3

12.2

5.75

3.85

2.7

0.7

24-Jul-17

61.15

11.2

5

3.35

2.3

0.6

21-Jul-17

59.65

9.75

3.9

2.55

1.85

0.5

20-Jul-17

59

9.15

3.7

2.3

1.6

0.35

19-Jul-17

58.5

8.8

3.55

2.2

1.55

0.35

17-Jul-17

58.2

8.75

3.6

2.2

1.65

0.4

17-Jul-17

58.35

9

3.2

2

1.8

0.5

14-Jul-17

57.45

8.35

3.5

1.65

1.7

0.45

13-Jul-17

57.25

8.25

3.55

2.5

1.75

0.5

12-Jul-17

57.55

8.4

3.7

2.7

1.9

0.6

11-Jul-17

56.55

7.95

3.5

2.55

1.8

0.55

10-Jul-17

58.4

9.4

4.4

3.25

2.35

0.8

07-Jul-17

56.45

7.95

3.5

2.5

1.8

0.55

06-Jul-17

57.6

8.9

4.15

3.05

2.2

0.75

05-Jul-17

55.7

7.25

3.05

2.15

1.5

0.45

04-Jul-17

53.65

5.6

2

1.35

0.85

0.2

03-Jul-17

54.25

6.05

2.3

1.6

1.05

0.3

30-Jun-17

53.9

6.2

2.3

1.6

1.1

0.3

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The following table explains the market price and premium of calls. The first column explains trading date Second column explains SPOT market price in cash segment on that date. The third column explains call premiums amounting at these strike prices OBSERVATIONS AND INTERPRETATION: CALL OPTION BUYERS PAY OFF: Those who have purchased call option at a strike price of 60, the premium payable is 1.6 On the expiry date the spot market price enclosed at 59.7. As it is out of the money for the buyer and in the money for the seller, hence the buyer is in loss. So the buyer will lose only 1.6 premium i.e. 1.6 per share. So the total loss will be 3360 i.e.1.6*2100 SELLERS PAY OFF: As seller is entitled only for premium if he is in profit. So his profit is only premium 3360 i.e.1.6*2100

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IDBI PUT OPTION STRIKE PRICE Date

FUTUREPRICE

50

57.5

60

62.5

70

26-Jul-17

59.7

0.2

1.55

2.8

5

10.7

27-Jul-17

59.9

0.3

1.55

2.65

4.25

10

26-Jul-17

62.85

0.1

0.85

1.6

2.8

7.9

25-Jul-17

62.3

0.1

1.05

1.75

3.15

8.6

24-Jul-17

61.15

0.15

1.4

2

3.75

9.35

21-Jul-17

59.65

0.4

1.95

3.2

4.65

10.7

20-Jul-17

59

0.35

2.3

3.6

5.2

11.4

19-Jul-17

58.5

0.45

2.3

3.95

5.6

11.8

17-Jul-17

58.2

0.5

2.35

3.55

5.8

12

17-Jul-17

58.35

0.55

3

4.15

5.75

11.85

14-Jul-17

57.45

0.75

3.35

4.8

6.5

12.7

13-Jul-17

57.25

0.85

3.6

5.05

6.75

12.95

12-Jul-17

57.55

0.95

3.7

5.15

6.85

12.95

11-Jul-17

56.55

1.15

4.15

5.65

7.4

13.6

10-Jul-17

58.4

0.8

3.3

4.6

6.2

12.05

07-Jul-17

56.45

1.1

4.1

5.6

6.75

13.5

06-Jul-17

57.6

1

3.65

5.05

6.7

12.65

05-Jul-17

55.7

1.25

4.45

6.05

7.85

14.25

04-Jul-17

53.65

1.6

5.4

7.25

9.25

16

03-Jul-17

54.25

1.6

5.25

7

8.95

15.6

29-jul-17

53.9

1.6

5.7

7.45

9.4

9.6

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OBSERVATIONS AND INTERPRETATION PUT OPTION BUYERS PAY OFF: If a person brought 1 lot of IDBI that is 2100, those who buy for 70 paid 9.6 premium per share and spot price is 59.7 Strike price = 70.00 Spot Price = 59.70 10.30 Premium (-) 9.60  

1.70 *2100 =1470 Buyers Profit = Rs. 1470 Because it is positive it is in the money contract hence buyer will get more profit, In case spot price decreases, buyer‘s profit will increase.

SELLERS PAYOFF:  It is in the money for the buyer so it is in out of the money for the seller, hence he is in loss.  The loss is equal to the profit of buyer i.e. 1470 OBSERVATIONS AND INTERPRETATIONS  

The future price of ICICI is moving along with the market price. If the buy price of the future is less than the settlement price, than the buyer of a future gets profit.



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

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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 the market price of the underlying asset. The investor may incur Hugh profits or he may incur Hugh loss.





But in derivatives segment the investor enjoys Hugh 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.



SUGGESITIONS 



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 ONGC is having low volatility, so the call option writer enjoys 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. 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

 41 | P a g e

BIBILOGRAPHY: 

Ms. Shalini H S1 , Dr. Raveendra P V2 1Department of MBA, Krupanidhi School of Management, Bangalore, Karnataka, India. IOSR Journal of Economics and Finance - ISSN: 2321-5933, (Mar-Apr. 2014)



B. Brahmaiah and Rao P. Subba, "Financial futures and option", 1st ed., Himalaya Publishing House, New Delhi, 1998, PP.25-147.



M. Gurusamy, and J. Sachin, "Financial derivatives", 1st ed., Ramesh Book Depot, New Delhi, 2009-10, PP.1.01-5.10



S.S.S. Kumar, "Financial derivatives", 2nd Pr., PHI Learning Private Ltd., New Delhi, 2008, PP.1-27, 57-306



S.L. Gupta, "Financial derivatives", 6th Pr., PHI Learning Private Ltd., New Delhi, 2009, PP.3-551.



Robert M. Hayes (2002), "Financial derivatives" available at : http://Polaris.gseis.usla.edu/rhaes/ courses/other/financial%20 derivatives.ppt. (accessed on October 20, 2012)

 WEBSITES : o www.derivativesindia.com o www.sharekhan.com o www.nseindia.com o www.bseindia.com o www.sebi.gov.in

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