Motilal Project

PROJECT REPORT ON

“Use Of Futures & Options In Bearish Market” IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE DEGREE OF

MASTE R OF B USI NESS ADM IN IST RATIO N

BY Mr. Sanjay Goplani UNDER THE GUIDANCE OF Mr. Himanshu Tiwari

Datta Meghe Institute Of Management Studies, Nagpur

2009-2010

CERTIFICATE This is to certify that Mr Sanjay Goplani is a bonafide student of

Datta Meghe

Institute of Management Studies, Nagpur and studying in MBA part II and has completed his Summer Internship Program at Motilal Securities Pvt. Ltd. And Submitted Report on topic “Use Of Future & Options In Bearish Market” under my complete guidance and supervision.

This

project

report

is

submitted

to

RTM

Nagpur

University

in

partial

fulfillment of academic requirement for the Degree of Master of Business Administration during the academic year 2008-2009. I find the work comprehensive, complete and of sufficiently high standard to warrant its presentation.

Guide Director

Mr. Himanshu Tiwari

Dr. Amishi Arora

Date: Place:

Nagpur

DECLARATION I Sanjay Choithram Goplani, a student of M.B.A. Part II of DMIMS, Nagpur hereby declare that , the project entitled “

“Use

Of Futures & Options In Bearish Market” or Part there of has not been

previously submitted by me for any other Degree or diploma of any University or Scientific Organization. The Project is the result of my bonafide work and source of literature used and all assistance received during the course of investigation have duly acknowledged.

Date: Place: Nagpur

Mayank pal

ACKNOWLEDGEMENT I take this opportunity to convey my gratitude to those who provided me help during the course of my study.

It is indeed a great pleasure to express my sincere thanks and great sense of gratitude to Mr. Himanshu Tiwari for his invaluable guidance, timely help and suggestion and constant encouragement during my project work.

I take opportunity to express sincere thanks to teaching and non teaching staff of Datta Meghe Institute Of Management Studies, Nagpur. Also I’m thankful to the branch head Mr.Prashant Pimplwar, my mentor Mr. Prashish Bharne ,and Mr.harish at motilal oswal securities ltd. Nagpur Branch.

Lastly I’m thankful to my Parents and Friends for keeping my spirit alive through the course of my project.

Date:Place: - Nagpur

sanjay goplani

INTRODUCTION

Futures and options Futures and options represent two of the most common form of "Derivatives". Derivatives are financial instruments that derive their value from an 'underlying'. The underlying can be a stock issued by a company, a currency, Gold etc., The derivative instrument can be traded independently of the underlying asset. The value of the derivative instrument changes according to the changes in the value of the underlying. Derivatives are of two types -- exchange traded and over the counter. Exchange traded derivatives, as the name signifies are traded through organized exchanges around the world. These instruments can be bought and sold through these exchanges, just like the stock market. Some of the common exchange traded derivative instruments are futures and options. Over the counter (popularly known as OTC) derivatives are not traded through the exchanges. They are not standardized and have varied features. Some of the popular OTC instruments are forwards, swaps, swaptions etc.

Futures A 'Future' is a contract to buy or sell the underlying asset for a specific price at a pre-determined time. If you buy a futures contract, it means that you promise to pay the price of the asset at a specified time. If you sell a future, you effectively make a promise to transfer the asset to the buyer of the future at a specified price at a particular time. Every futures contract has the following features: • • • • •

Buyer Seller Price Expiry Some of the most popular assets on which futures contracts are available are equity stocks, indices, commodities and currency.

The difference between the price of the underlying asset in the spot market and the futures market is called 'Basis'. (As 'spot market' is a market for immediate delivery) The basis is usually negative, which means that the price of the asset in the futures market is more than the price in the spot market. This is because of the interest cost, storage cost, insurance premium etc., That is, if you buy the asset in the spot market, you will be incurring all these expenses, which are not needed if you buy a futures contract. This condition of basis being negative is called as 'Contango'. Sometimes it is more profitable to hold the asset in physical form than in the form of futures. For eg: if you hold equity shares in your account you will receive dividends, whereas if you hold equity futures you will not be eligible for any dividend. When these benefits overshadow the expenses associated with the holding of the asset, the basis becomes positive (i.e., the price of the asset in the spot market is more than in the futures market). This condition is called 'Backwardation'. Backwardation generally happens if the price of the asset is expected to fall. It is common that, as the futures contract approaches maturity, the futures price and the spot price tend to close in the gap between them ie., the basis slowly becomes zero.

Options Options contracts are instruments that give the holder of the instrument the right to buy or sell the underlying asset at a predetermined price. An option can be a 'call' option or a 'put' option. A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is called 'strike price'. It should be noted that while the holder of the call option has a right to demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if the buyer wants to buy the asset, the seller has to sell it. He does not have a right. Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer. Here the buyer has the right to sell and the seller has the obligation to buy. So in any options contract, the right to exercise the option is vested with the buyer of the contract. The seller of the contract has only the obligation and no right. As the seller of the contract bears the obligation, he is paid a price called as 'premium'. Therefore the price that is paid for buying an option contract is called as premium.

RESEARCH METHODOLOGY

OBJECTIVES . •

To understand the concept and benefits of Hedging.

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Hedging principles used in Futures and Options market.

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To plan different strategies used in Futures and Options to minimize the losses of clients.

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To show that losses can be avoided even if the market is falling.

Methodology of the project starts with: •

In the first phase we are trained and they teach us different things about futures and options market.

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After that I have gone through the data related to Futures and Options market to understand the main problem that people were facing during recession and due to that were not able to cope up with their losses.

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I’ve understood that people were in losses because they were looking Futures as an investment segment but not as a hedging tool and they were not aware of options market.

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Then after that we have applied, different hedging strategies on the data of recession period related to Futures and Options segment that could be used there to minimize the losses.

The next part knows the pattern of the Index based Futures and Options market. How they move with the correspondence to the market movement and also the economy. •

Get the knowledge of technical as well as fundamental methods.

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Observe the patterns of the Futures and Options market used individually and mutually.

LIMITATIONS

The various Limitations are:-•

Lack of awareness about Futures and Options segment: - Since the area is not known before it takes lot of time in convincing people to start investing in Futures and Options market for hedging purpose.

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Mostly people comfortable with traditional brokers: -- As people are doing trading from there respective brokers, they are quite comfortable to trade via phone.

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Lack of Techno Savvy people and poor internet penetration: -- Since most of the people are quite experienced and also they are not techno savvy. Also internet penetration is poor in India.

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Some respondents are unwilling to talk: - Some respondents either do not have time or willing does not respond as they are quite annoyed with the adverse market conditions they faced so far.

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Misleading concepts: - Some people think that Derivatives are too risky and just another name of gamble but they don’t know it’s not at all that risky for long investors.

Company Profile

The story of Motilal Oswal Securities Ltd goes back many years, when Mr. Motilal Oswal and Mr. Raamdeo Agrawal met each other as students in a Mumbai suburban hostel in the early eighties. Both the young chartered accountants hailing from a rural & an unpretentious background had a common dream viz 'to build a professional organization with strong value systems, to provide reliable & honest investment advice to investors'. Thus was born their first enterprise called "Prudential Portfolio Services" in 1987. Motilal Oswal Securities Ltd. was founded in 1987 as a small sub-broking unit, with just two people running the show. Focus on customer-first-attitude, ethical and transparent business practices, respect for professionalism, research-based value investing and implementation of cutting-edge technology has enabled us to blossom into an almost 2000 member team.

SUCCESS MANTRA FOR MOSL: The success story of MOSL is driven by 8 success sutras adopted by it namely: Trust, Integrity, Dedication, Commitment, Enterprise, Hardwork and Teamplay, Learning and Innovation, Empathy and Humility. These are the values that bind success with MOSL.

Mission Statement: “To be a well-respected and preferred global financial services organisation enabling wealth creation for all our customers.” Today MOSL is a well diversified financial services firm offering a range of financial products and services such as

       

Wealth Management Broking & Distribution Commodity Broking Portfolio Management Services Institutional Equities Private Equity Investment Banking Services and Principal Strategies

MOSL has a diversified client base that includes retail customers (including High Net worth

Individuals), mutual funds, foreign institutional investors, financial institutions and corporate clients. MOSL are headquartered in Mumbai and as of March 31st, 2009, had a network spread over 548 cities and towns comprising 1,289 Business Locations operated by our Business Partners and us. As at March 31st, 2009, we had 541372 registered customers. In 2006, the Company placed 9.48% of its equity with two leading private equity investors based out of the US – New Vernon Private Equity Limited and Bessemer Venture Partners. The company got listed on BSE and NSE on September 9, 2007. The issue which was priced at Rs.825 per share (face value Rs.5 per share) got overwhelming response and was subscribed 27.18 times in turbulent market conditions. The issue gave a return of 21% on the date of listing. As of end of financial year 2008, the group net worth was Rs.7 bn. and market capitalization as of March 31, 2008 was Rs.19 bn. For year ended March 2008, the company showed a strong top line growth of 91% to Rs.7 bn. as compared to Rs.3.68 bn. last year. New businesses like investment banking, asset management and fund based activities have contributed to this growth. Credit rating agency Crisil has assigned the highest rating of P1+ to the Company’s short-term debt program. Shareholding Pattern at on 31st December 08 As of December 31st, 2008; the total shareholding of the Promoter and Promoter Group stood at 70.37%. The shareholding of institutions stood at 10.07% and non-institutions at 19.56%. Their Business Streams Our businesses and primary products and services are: Wealth Management Financial planning for individual, family and business wealth creation and management needs. These are provided to customers through our Wealth Management service called ‘Purple’

Broking & Distribution services       

Equity (cash and derivatives) Commodity Broking Portfolio Management Services Distribution of financial products Financing Depository Services IPO distribution

We offer these services through our branches, Business Partner locations, the internet and mobile channels. We also have strategic tie-ups with State Bank of India and IDBI Bank to offer our online trading platform to its customers.

Commodity Broking Through Motilal Oswal Commodities Broker (P) Ltd our fully owned subsidiary; we provide commodity trading facilities and related products and services on MCX and NCDEX. Besides access to the best of research in the form of Daily Fundamentals & Technical Reports on highly traded commodities, our clients also get access to our exclusive Customized Trading Advice on both the trading platforms. We offer these services through our branches, Business Partner locations, the internet and mobile channels

Portfolio Management Services

Motilal Oswal Portfolio Management Services offer a range of investments solutions through discretionary services. We at Motilal Oswal have helped create wealth for our customers through our Portfolio Management Services. Our knowledge of the markets together with our understanding of our customers and their risk profiles has helped us design a range of portfolio offerings for our clients. These include the Value Strategy, Bulls Eye Strategy, Trillion Dollar Opportunity Strategy and Focused Strategy Series I. As of March 31st, 2009, the Assets Under Management of our various portfolio schemes stood at Rs.4.77 bn. Motilal Oswal group has applied to the regulatory bodies for a license to operate as a Domestic Asset Management Company (Mutual Fund) and we expect to begin operations soon.

Institutional Equities

We offer equity broking services in the cash and derivative segments to institutional clients in India and overseas. These clients include companies, mutual funds, banks, financial institutions, insurance companies, and FIIs. As at March 31st, 2009, we were empanelled with over 300 institutional clients including 200 FIIs. We service these clients through dedicated sales teams across different time zones.

Investment Banking We offer financial advisory services relating to mergers and acquisitions (domestic and crossborder), divestitures, restructurings and spin-offs through Motilal Oswal Investment Advisors Private Ltd. (MOIAPL) We also offer capital raising and other investment banking services such as the management of public offerings, private placements (including qualified institutional placements), rights issues, share buybacks, open offers/delistings and syndication of debt and equity. MOIAPL has closed 23 transactions in 2007-08 worth US$ 1.8 billion and had 18 mandates in hand as at March 31, 2008.

Private Equity In 2006, our private equity subsidiary, Motilal Oswal Private Equity Advisors Private Ltd (MOPEAPL) was appointed as the investment manager and advisor to a private equity fund, India Business Excellence Fund, which was launched with a target of raising US$100 million.

The fund is aimed at providing growth capital to small and medium enterprises in India, with investments typically in the range of US$3 million to US$7 million. MOPEAPL will manage and advise the fund and other private equity funds, which may be raised in the future. In its final closing, in December 2007, the fund obtained commitments of US$125 mn (Rs.4,875 mn) from investors in India and overseas. The Fund has deployed/ committed $ 58 mn across 8 deals. MOPEAPL has recently launched an INR 750 crores domestic Real Estate Private Equity Fund called “India Realty Excellence Fund” sponsored by Motilal Oswal Financial Services Ltd.

Principal Strategies Group

For effective management of treasury operations and to capitalize on market opportunities, the Group has set up a 30 member team which would be responsible for effective deployment of funds into different trading and arbitrage strategies.

Focus on Research Research is the solid foundation on which Motilal Oswal Securities advice is based. Almost 10% of revenue is invested on equity research and we hire and train the best resources to become advisors. At present we have 22 equity analysts researching over 27 sectors. From a fundamental, technical and derivatives research perspective; Motilal Oswal's research reports have received wide coverage in the media (over a 1000 mentions last year). Our consistent efforts towards quality equity research has reflected in an increase in the ratings and rankings across various categories in the AsiaMoney Brokers Poll over the years Our unique Wealth Creation Study, authored by Mr. Raamdeo Agrawal, Managing Director, is now in its 13th year. Investors keenly await this annual study for the wealth of information it has on the companies that created wealth during the preceding five years.

Awards and Accolades Motilal Oswal Financial Services has received many accolades in the year gone by. Some of them are: • • • •

Rated ‘Best Overall Country Research’ for a Local Brokerage in the 2007 AsiaMoney Brokers poll Rated India’s top broking house in terms of total number of trading terminals by the Dun & Bradstreet survey Rated ‘Outstanding Commodity Broking House-2007’ by Globoil India Ranked second best for Customer Responsiveness in the Financial Sector at the Avaya GlobalConnect Customer Responsiveness awards.

Corporate offices & Branches

BRANCH-HEAD OFFICE Palm Spring Centre, 2nd Floor, Palm Court Complex, New Link Road, Malad (West), Mumbai 400 064, Maharashtra, India.

LOCATION OF SIP COMPANY Motilal Oswal Securities Ltd. Pukhraj House (Super Franchisee), VIP Road, Dharampeth, Nagpur.-440010, Maharashtra. Tel.:0712-2554495, 3291306, 3291304

FUTURES AND OPTIONS Futures & options are derivatives, which derive their values from equity as their underlying. Hence our Equity Advisory Group (EAG), equipped with all the required skills and understanding of Equity Derivatives, will act as your advisors in futures & options segment as well to help you take informed trading decisions.

Why Futures and Options Derivatives instruments are primarily hedging tools. Clients can be assisted in protecting the downside risk to their portfolio using appropriate combination of options. Our advisory is skilled to help you in maximizing your gains from your existing corpus using numerous

strategies based on the direction and intensity of the views. Derivatives give an ability to leverage; given the risk appetite clients can extrapolate their gains with the timely assistance of our advisory. The Equity Advisor doesn’t stop at just that, he goes a step further to ensure that your trades are settled and traded with proper margin in your account in a timely manner. This allows us to give you a convenient single window service and your advisor becomes the single point contact for all your equity related matters. You can avail of our services from all our Business locations and through E broking across India, as in equities. EAG Process (Derivatives) Client Profiling: MOSL Equity Advisor determines each EAG client's profile before deciding the set of derivative strategies that will ideally suit you. If you have a good risk appetite & are willing to take riskier bets for reciprocating returns, we will suggest aggressive strategies like buying naked futures. On the other hand, if you are risk averse and would like to protect yourself moderating some of your incremental gains but finding it difficult to digest the bouts of volatility in the markets, we can suggest certain portfolio hedging strategies to ease your worries. Trading: The MOSL Equity Advisor is an expert in swift & timely execution of trading ideas at the same time monitoring those ideas as per your profile. Integrated Approach: We use integrated approach in our trading strategy using a combination of futures and/or calls and/ or puts to help you optimally capitalize your view reach your trading goal. Portfolio Tracking Software: Your F&O position will be continuously monitored using Portfolio Tracking Software. Minimum requirements and fees structure: Margins as per NSE requirement and fees structure varies from case to case.

Normal Fees: Derivatives 0.10%. Our Company is a member of the National Stock Exchange, which provides equity and derivative trades execution through offline and online channels for the customers.

The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse Investors. There are three major classes of derivatives: •

Forward Contracts: A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges. • Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchangetraded contracts. •

Options: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. • Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: · 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.

History of Futures and Options

History of futures The origins of futures trading can be traced to Ancient Greek, in Aristotle's writings. He tells the story of Thales, a poor philosopher from Miletus who developed a "financial device, which involves a principle of universal application." Thales used his skill in forecasting and predicted that the olive harvest would be exceptionally good the next autumn. Confident in his prediction, he made agreements with local olive-press owners to deposit his money with them to guarantee him exclusive use of their olive presses when the harvest was ready. Thales successfully negotiated low prices because the harvest was in the future and no one knew whether the harvest would be plentiful or pathetic and because the olive-press owners were willing to hedge against the possibility of a poor yield. When the harvest-time came, and a sharp increase in demand for the use of the olive presses outstripped supply, he sold his future use contracts of the olive presses at a rate of his choosing, and made a large quantity of money.

Introduction to Futures: Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard 27 features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way. The standardized items in a futures contract are: · Quantity of the underlying · Quality of the underlying · The date and the month of delivery · The units of price quotation and minimum price change

· Location of settlement

Futures Terminology •

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

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

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Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one- month, two-months and three months expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three- month expiry is introduced for trading.

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Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.

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Contract size: The amount of asset that has to be delivered under one contract. Also called as lot size.

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Basis: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices.

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Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

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Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

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Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking-to-market.

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Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If 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 before trading commences on the next day.

History of Options It is not known when the first option contract traded; however, similar contracts can be traced back as far as the Romans and the Phoenicians, who used them in shipping, and ancient Greece, where a mathematician and philosopher named Thales used them to secure a low price for olive presses in advance of the harvest. They were also used in the tulip trading craze in Holland in the 1600s. Options appeared in America roughly the same time as stocks. At first they were not traded on an exchange; trades were done privately between buyers and sellers. Growth in options trading remained slow for the next few decades, mostly because trading by phone without being able to determine the real market for a contract made them illiquid and cumbersome to trade.

Introduction to 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 requirements) to enter into a futures contract, the purchase of an option requires an up-front payment.

Options Terminology • Index options: These options have the index as the underlying. Some options are European while others are American. Like index futures contracts, index options Contracts are also cash settled. •

Stock options: Stock options are options on individual stoc ks. 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.

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Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.

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Writer of an option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.

There are two basic types of options, call options and put options: • Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. •

Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. •

Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.

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Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity.

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Strike price: The price specified in the options contract is known as the strike price or the exercise price.

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American options: American options are options that can be exercised at any time upto the expiration date. Most exchange-traded options are American.

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European options: 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. In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cashflow to the holder if it were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price.

•

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At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cashflow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price(i.e. spot price = strike price). • Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cashflow if it were exercised immediately. A call option on the index is out-of-the-money when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price.

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Intrinsic value of an option: The option premium can be broken down into two components - intrinsic value and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max [0, (St — K)] which means 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 — St). K is the strike price and St is the spot price.

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Time value of an option: The time value of an option is the difference between its premium and its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an option's time value, all else equal. At expiration, an option should have no time value.

What Is Hedging? The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday. For example, if you buy house insurance, you are hedging yourself against fires, break-ins or other unforeseen disasters. Portfolio managers, individual investors and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another. Technically, to hedge you would invest in two securities with negative correlations. Of course, nothing in this world is free, so you still have to pay for this type of insurance in one form or

another. Although some of us may fantasize about a world where profit potentials are limitless but also risk free, hedging can't help us escape the hard reality of the risk-return tradeoff. A reduction in risk will always mean a reduction in potential profits. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss. If the investment you are hedging against makes money, you will have typically reduced the profit that you could have made, and if the investment loses money, your hedge, if successful, will reduce that loss.

How Do Investors Hedge? Hedging techniques generally involve the use of complicated financial instruments known as derivatives, the two most common of which are options and futures. We're not going to get into the nitty-gritty of describing how these instruments work, but for now just keep in mind that with these instruments you can develop trading strategies where a loss in one investment is offset by a gain in a derivative difficult to achieve in practice.

What Hedging Means to You The Downside Every hedge has a cost, so before you decide to use hedging, you must ask yourself if the benefits received from it justify the expense. Remember, the goal of hedging isn't to make money but to protect from losses. The cost of the hedge - whether it is the cost of an option or lost profits from being on the wrong side of a futures contract - cannot be avoided. This is the price you have to pay to avoid uncertainty. We've been comparing hedging versus insurance, but we should emphasize that insurance is far more precise than hedging. With insurance, you are completely compensated for your loss (usually minus a deductible). Hedging a portfolio isn't a perfect science and things can go wrong. Although risk managers are always aiming for the perfect hedge, it is The majority of investors will never trade a derivative contract in their life. In fact most buy-andhold investors ignore short-term fluctuation altogether. For these investors there is little point in engaging in hedging because they let their investments grow with the overall market.

So why learn about hedging? Even if you never hedge for your own portfolio you should understand how it works because many big companies and investment funds will hedge in some form. Oil companies, for example, might hedge against the price of oil while an international mutual fund might hedge against fluctuations in foreign exchange rates. An understanding of hedging will help you to comprehend and analyze these investments.

1. Options Strategies: Long Call Purchasing calls has remained the most popular strategy with investors since listed options were first introduced. Before moving into more complex bullish and bearish strategies, an investor should thoroughly understand the fundamentals about buying and holding call options.

Market Opinion ? Bullish to Very Bullish

When to Use? This strategy appeals to an investor who is generally more interested in the dollar amount of his initial investment and the leveraged financial reward that long calls can offer. The primary motivation of this investor is to realize financial reward from an increase in price of the

underlying security. Experience and precision are key to selecting the right option (expiration and/or strike price) for the most profitable result. In general, the more out-of-the-money the call is the more bullish the strategy, as bigger increases in the underlying stock price are required for the option to reach the break-even point.

2. Options Strategies: Long Put A long put can be an ideal tool for an investor who wishes to participate profitably from a downward price move in the underlying stock. Before moving into more complex bearish strategies, an investor should thoroughly understand the fundamentals about buying and holding put options.

Market Opinion? Bearish

When to Use? Purchasing puts without owning shares of the underlying stock is a purely directional strategy used for bearish speculation. The primary motivation of this investor is to realize financial reward from a decrease in price of the underlying security. This investor is generally more interested in the dollar amount of his initial investment and the leveraged financial reward that long puts can offer than in the number of contracts purchased.

Experience and precision are key in selecting the right option (expiration and/or strike price) for the most profitable result. In general, the more out-of-the-money the put purchased is the more bearish the strategy, as bigger decreases in the underlying stock price are required for the option to reach the break-even point.

3. Options Strategies: Married Put An investor purchasing a put while at the same time purchasing an equivalent number of shares of the underlying stock is establishing a "married put" position - a hedging strategy with a name from an old IRS ruling.

Market Opinion? Bullish to Very Bullish

When to Use? The investor employing the married put strategy wants the benefits of stock ownership (dividends, voting rights, etc.), but has concerns about unknown, near-term, downside market risks. Purchasing puts with the purchase of shares of the underlying stock is a directional and bullish strategy. The primary motivation of this investor is to protect his shares of the underlying security from a decrease in market price. He will generally purchase a number of put contracts equivalent to the number of shares held.

4. Options Strategies: Protective Put An investor who purchases a put option while holding shares of the underlying stock from a previous purchase is employing a "protective put."

Market Opinion? Bullish on the Underlying Stock

When to Use? The investor employing the protective put strategy owns shares of underlying stock from a previous purchase, and generally has unrealized profits accrued from an increase in value of those shares. He might have concerns about unknown, downside market risks in the near term and wants some protection for the gains in share value. Purchasing puts while holding shares of underlying stock is a directional strategy, but a bullish one.

5. Options Strategies: Covered Call The covered call is a strategy in which an investor writes a call option contract while at the same time owning an equivalent number of shares of the underlying stock. If this stock is purchased simultaneously with writing the call contract, the strategy is commonly referred to as a "buywrite." If the shares are already held from a previous purchase, it is commonly referred to an "overwrite." In either case, the stock is generally held in the same brokerage account from which the investor writes the call, and fully collateralizes, or "covers," the obligation conveyed by writing a call option contract. This strategy is the most basic and most widely used strategy combining the flexibility of listed options with stock ownership.

Market Opinion? Neutral to Bullish on the Underlying Stock

When to Use? Though the covered call can be utilized in any market condition, it is most often employed when the investor, while bullish on the underlying stock, feels that its market value will experience

little range over the lifetime of the call contract. The investor desires to either generate additional income (over dividends) from shares of the underlying stock, and/or provide a limited amount of protection against a decline in underlying stock value.

6. Options Strategies: Cash Secured Put According to the terms of a put contract, a put writer is obligated to purchase an equivalent number of underlying shares at the put's strike price if assigned an exercise notice on the written contract. Many investors write puts because they are willing to be assigned and acquire shares of the underlying stock in exchange for the premium received from the put's sale. For this discussion, a put writer's position will be considered as "cash-secured" if he has on deposit with his brokerage firm a cash amount (or equivalent) sufficient to cover such a purchase.

Market Opinion? Neutral to Slightly Bullish

When to Use? There are two key motivations for employing this strategy: either as an attempt to purchase underlying shares below current market price, or to collect and keep premium from the sale of puts which expire out-of-the-money and with no value. An investor should write a cash secured put only when he would be comfortable owning underlying shares, because assignment is always possible at any time before the put expires. In addition, he should be satisfied that the net cost for the shares will be at a satisfactory entry point if he is assigned an exercise. The number of put contracts written should correspond to the number of shares the investor is comfortable and financially capable of purchasing. While assignment may not be the objective at times, it should

not be a financial burden. This strategy can become speculative when more puts are written than the equivalent number of shares desired to own.

7. Options Strategies: Bull Call Spread Establishing a bull call spread involves the purchase of a call option on a particular underlying stock, while simultaneously writing a call option on the same underlying stock with the same expiration month, at a higher strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. This spread is sometimes more broadly categorized as a "vertical spread": a family of spreads involving options of the same stock, same expiration month, but different strike prices. They can be created with either all calls or all puts, and be bullish or bearish. The bull call spread, as any spread, can be executed as a"unit" in one single transaction, not as separate buy and sell transactions. For this bullish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm from an exchange where the options are listed and traded.

Market Opinion? Moderately Bullish to Bullish

When to Use? Moderately Bullish An investor often employs the bull call spread in moderately bullish market environments, and wants to capitalize on a modest advance in price of the underlying stock. If the investor's opinion is very bullish on a stock it will generally prove more profitable to make a simple call purchase.

Risk Reduction An investor will also turn to this spread when there is discomfort with either the cost of purchasing and holding the long call alone, or with the conviction of his bullish market opinion.

8. Options Strategies: Bear Put Spread Establishing a bear put spread involves the purchase of a put option on a particular underlying stock, while simultaneously writing a put option on the same underlying stock with the same expiration month, but with a lower strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. This spread is sometimes more broadly categorized as a "vertical spread": a family of spreads involving options of the same stock, same expiration month, but different strike prices. They can be created with either all calls or all puts, and be bullish or bearish. The bear put spread, as any spread, can be executed as a "package" in one single transaction, not as separate buy and sell transactions. For this bearish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm from an exchange where the options are listed and traded.

Market Opinion? Moderately Bearish to Bearish

When to Use? Moderately Bearish An investor often employs the bear put spread in moderately bearish market environments, and wants to capitalize on a modest decrease in price of the underlying stock. If the investor's opinion is very bearish on a stock it will generally prove more profitable to make a simple put purchase.

Risk Reduction An investor will also turn to this spread when there is discomfort with either the cost of purchasing and holding the long put alone, or with the conviction of his bearish market opinion.

9. Options Strategies: Collar A collar can be established by holding shares of an underlying stock, purchasing a protective put and writing a covered call on that stock. The option portions of this strategy are referred to as a combination. Generally, the put and the call are both out-of-the-money when this combination is established, and have the same expiration month. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. In other words, one collar equals one long put and one written call along with owning 100 shares of the underlying stock. The primary concern in employing a collar is protection of profits accrued from underlying shares rather than increasing returns on the upside.

Market Opinion? Neutral, following a period of appreciation

When to Use? An investor will employ this strategy after accruing unrealized profits from the underlying shares, and wants to protect these gains with the purchase of a protective put. At the same time, the investor is willing to sell his stock at a price higher than current market price so an out-ofthe-money call contract is written, covered in this case by the underlying stock.

10.Options Strategies: Long Straddle The long straddle is simply the simultaneous purchase of a long call and a long put on the same underlying security with both options having the same expiration and same strike price. Because the position includes both a long call and a long put, the investor in a straddle should have a complete understanding of the risks and rewards associated with both long calls and long puts. **Since the straddle involves two trades, a commission charge is likely for the purchase (and any subsequent sale) of each position -- one commission for the call and one commission for the put.

Market Opinion? Increasing volatility and large price swings in the underlying security. Potentially profit from a big move, either up or down, in the underlying price during the life of the options.

When to Use? Purchasing only long calls or only long puts is primarily a directional strategy. The long straddle however, consisting of both long calls and long puts is not a directional strategy, rather it is one where the investor feels large price swings are forthcoming but is unsure of the direction. This strategy may prove beneficial when the investor feels large price movement, either up or down, is imminent but is uncertain of the direction.

An instance of when a straddle may be considered is when the investor believes there is news forthcoming. An example may be when one is anticipating news regarding a drug in trials from a biotechnology company. The investor feels the news surrounding the drug will introduce large price swings in the underlying but is unsure of whether this news will have a positive or negative impact on the price. If the news is positive, this may positively impact the price of the security. If the news is disappointing, the stock could decline considerably. The risk is the stock remaining at the strike price of the straddle until expiration.

11.Options Strategies: Long Strangle The long strangle is simply the simultaneous purchase of a long call and a long put on the same underlying security with both options having the same expiration but where the put strike price is lower than the call strike price. Because the position includes both a long call and a long put, the investor using a long strangle should have a complete understanding of the risks and rewards associated with both long calls and long puts.

Market Opinion? Increasing volatility and extremely large price swings in the underlying security. Potentially profit from a large move, either up or down, in the underlying price during the life of the options.

When to Use? Purchasing only long calls or only long puts is primarily a directional strategy. The long strangle however, consisting of both long calls and long puts is a not a directional strategy, rather one where the investor feels extremely large price swings are forthcoming but is unsure of the direction. This strategy may prove beneficial when the investor feels large price movement, either up or down, is about to happen but uncertain of the direction. An instance of when a strangle may be considered is when an earnings announcement is forthcoming. The investor feels the projected announcement will introduce large price swings in the underlying. If the earnings announcement and future outlook is positive, this may positively

impact the price of the security. If the earning announcement and outlook is negative, or fails to impress investors, the stock could decline considerably. The risk is the stock remains stable or between the strike price of the call and strike price of the put until expiration. Another risk is that the stock's move does not produce a corresponding option price increase that is enough to cover the two premiums paid for the position. Declining implied volatility will also negatively impact this strategy.

Conclusion

Derivatives are extremely important and have a big impact on other financial market and the economy. The project is designed to upgrade investor’s knowledge with the basics of how to make investment decisions in futures & options with reference to bear market. Analyze the fundamental, technical and other factors for dealing in futures & options. Hedging is for minimizing risk not for maximizing the profit. For many investors, options are useful as tools of risk management.

Bibliography:-

1) Derivatives Market (Basic) Module:--NCFM 2) Economic Times 3) Business Standard 4) www.Motilaloswal.com 5) www.nseindia.com 6) www.moneycontrol.com 7) www.derivativesindia.com

8) A Beginner's Guide To Hedging