Executive SummaryThe project is being made to enhance the knowledge and to ascertain the

amount of awareness about derivatives. The derivatives is proven better

as compared to equity. The Stock market industry is being taken this as a

very crucial matter with the contrast of the many other important

characteristics. The derivatives are the means of having a so called

initiative among the investors but it not done fully. The investors should

be conveyed its importance and the necessary things such as call, option ,

put , mutual funds etc. The margin requirements is also being

commendable in the derivatives and are used and being information and

its usage is spreading in the investors. A derivative is 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. The

derivatives may be regarded as a better option to undertaken as is being

exercised under a authority of by-laws. The derivatives is also new and a

beneficial option regarded as a contract which derives its value from the

prices, or index of prices, of underlying securities.

1

Scope

The scope of the study will include the analysis of the survey, which is

being conducted to know the awareness of the Derivative Market in the

city & also doing comparison of derivatives with equity . It may include

the analysis regarding the investors who use the derivatives and its

awareness to them. The derivative is being regarded as the important

aspect in this and may include Mutual funds, Put , Option, Depositories,

Call , Futures , forwards etc. The Commodity and metal indexes also

becomes a crucial part of it and may regarded as an important separate

indexes such NCDEX and MCX. The Derivatives may also include the

evolving measures to safeguard the investors and for that Securities and

Exchange Board of India is taking several measures in the day trading and

also take into account all precautions .

2

Objective

To know the awareness of the Derivative Market in Delhi City.

To know which one is beneficial for the investor.

To find what proportion of the population are investing in such

derivatives along with their investment pattern and product

preferences.

4.To gain some knowledge out of it by understanding the main

issues and criteria of financial market.

5.To have some experience of trading in the share market and

understanding the relevance of both derivatives and equity.

3

Limitation

The limitations of the project was that the project made is being

undertaken for only two months so the proper information may

not be got . The second one is that the data taken are the clients

of the company and might they may not be interested in giving

the correct information as it may a disadvantage of human

behaviour. These are limitations must be seen in the project as if

more depth will require more and more analysis on a particular

topic to reach at a final result.

4

Methodology

Problem Statement:

The topic, which is selected for the study, is “Derivative Market” in the

firm so the problem statement for this study will be, “Study of Dervatives

and its comparison with equity”

Research Source of Data:-

There are two types of sources of data which is being used for the

studies:-

Primary Source of Data:

Preparing a Questionnaire is collecting the primary source of data & it

was collected by interviewing the investors.

Secondary Source of Data:

For having the detailed study about this topic, it is necessary to have some

of the secondary information, which is collected from the following:-

Books. Magazines & Journals. Websites. Newspapers, etc.

Methods of Data Collection:-

The study to be conducted is about the awareness of the Derivative

Market in the Delhi City so the method of data collection used is “Survey

Method”.

Research Design:

The research design specifies the methods and procedures for conducting

a particular study. The type of research design applied here are

“Descriptive” as the objective is to check the position of the Derivative

Market in Delhi city. The objectives of the study have restricted the

choice of research design up to descriptive research design.

5

IntroductionHistory of the Stock Broking Industry

Indian Stock Markets are one of the oldest in Asia. Its history dates

back to nearly 200 years ago. In 1887, they formally established in

Bombay, the "Native Share and Stock Brokers' Association" (which is

alternatively known as "The Stock Exchange"). In 1895, the Stock

Exchange acquired a premise in the same street and it was inaugurated in

1899. Thus, the Stock Exchange at Bombay was consolidated.

Thus in the same way, gradually

with the passage of time number of exchanges were increased and at

currently it reached to the figure of 24 stock exchanges. This was

followed by the formation of associations /exchanges in Ahmadabad

(1894), Calcutta (1908), and Madras (1937).

In order to check such aberrations and

promote a more orderly development of the stock market, the central

government introduced a legislation called the Securities Contracts

(Regulation) Act, 1956. Under this legislation, it is mandatory on the part

of stock exchanges to seek government recognition. As of January 2002

there were 23 stock exchanges recognized by the central Government.

They are located at Ahmadabad, Bangalore, Baroda, Bhubaneswar,

Calcutta, Chennai, (the Madras stock Exchanges), Cochin, Coimbatore,

Delhi, Guwahati, Hyderabad, Indore, Jaipur, Kanpur, Ludhiana,

Mangalore, Mumbai (the National Stock Exchange or NSE), Mumbai

(The Stock Exchange), popularly called the Bombay Stock Exchange,

Mumbai (OTC Exchange of India), Mumbai (The Inter-connected Stock

Exchange of India), Patna, Pune, and Rajkot. Of course, the principle

6

bourses are the National Stock Exchange and The Bombay Stock

Exchange, accounting for the bulk of the business done on the Indian

stock market.

Basis of Trading

The NEAT F&O system supports an order driven market, wherein orders

match automatically. Order matching is essentially on the basis of

security, its 73 price, time and quantity. All quantity fields are in units and

price in rupees.The exchange notifies the regular lot size and tick size for

each of the contracts traded on this segment from time to time. When any

order enters the trading system, it is an active order. It tries to find a match

on the other side of the book. If it finds a match, a trade is generated. If it

does not find a match, the order becomes passive and goes and sits in the

respective outstanding order book in the system.

Corporate hierarchy

In the F&O trading software, a trading member has the facility of defining

a hierarchy amongst users of the system. This hierarchy comprises

corporate manager, branch manager and dealer.

Corporate manager: The term 'Corporate manager' is assigned to a

user placed at the highest level in a trading firm. Such a user can

perform all the functions such as order and trade related activities,

receiving reports for all branches of the trading member firm and

also all dealers of the firm. Additionally, a corporate manager can

define exposure limits for the branches of the firm. This facility is

available only to the corporate manager.

7

Branch manager: The branch manager is a term assigned to a user

who is placed under the corporate manager. Such a user can

perform and view order and trade related activities for all deale rs

under that branch.

Dealer: Dealers are users at the lower most level of the hierarchy.

A Dealer can perform view order and trade related activities only

for oneself and does not have access to information on other dealers

undereither the same branch or other branches.

BSE (Bombay Stock Exchange)

The Stock Exchange, Mumbai, popularly known as" BSE" was

established in 1875 as "The Native Share and Stock Brokers

Association". It is the oldest one in Asia, even older than the Tokyo Stock

Exchange, which was established in 1878. It is the first Stock Exchange in

the Country to have obtained permanent recognition in 1956 from the

Govt. of India under the Securities Contracts (Regulation) Act, 1956.

A Governing Board having 20 directors is the apex body, which decides

the policies and regulates the affairs of the Exchange. The Governing

Board consists of 9 elected directors, who are from the broking comm.

Unity (one third of them retire ever year by rotation), three SEBI

nominees, six public representatives and an Executive Director & Chief

Executive Officer and a Chief Operating Officer.

NSE (National Stock Exchange)

NSE was incorporated in 1992 and was given recognition as a stock

exchange in April 1993. It started operations in June 1994, with trading on

the Wholesale Debt Market Segment. Subsequently it launched the

8

Capital Market Segment in November 1994 as a trading platform for

equities and the Futures and Options Segment in June 2000 for various

derivative instruments.

MCX (Multi Commodity Exchange)

‘Multi Commodity Exchange’ of India limited is a new order exchange

with a mandate for setting up a nationwide, online multi- commodity

market place, offering unlimited growth opportunities to commodities

market participants. As a true neutral market, MCX has taken several

initiatives for users in a new generation commodities futures market in the

process, become the country’s premier exchange. MCX , an independent

and a de-mutualized exchange since inception, is all set up to introduce a

state of the atr, online digital exchange for commodities futures trading in

the country and has accordingly initiated several steps to translate this

vision into reality.

NCDEX (National Commodities and Derivatives Exchange)

NCDEX started working on 15th December ,2003. This exchange provides

facilities to their trading members at different 130 contract. In commodity

market the main participants are speculators, hedgers and arbitrageurs.

Facilities Provided by NCDEX

NCDEX has developed a facility for checking of commodity and

also provides awarehouse facility.

9

By collaborating with industrial companies, industrial partners,

news agencies, banks and developers of kiosk network. NCDEX is

able to provide current rates and contract rates.

To prepare guidelines related to special products of securitization

NCDEX works with bank.

To avail farmers from risk of fluctuation in prices of NCDEX

provides special services for agriculture.

NCDEX is working with tax officer to make a clear different types

of sales and service tax.

NCDEX is providing attractive products like “weather

Dervatives”.

Stock Market Basic

Companies are started by individuals or may be a small circle of people.

They pool their money or obtain loans, raising funds to launch the

business.

A choice is made to organize the business as a sole proprietorship

where one Person or a married couple owns everything, or as a

partnership

with others who may wish to invest money. Later they may choose

to "incorporate". As a Corporation, the owners are not personally

responsible or liable for any debts of the company if the company doesn't

succeed. Corporations issue official-looking sheets of paper that represent

ownership of the company. These are called stock certificates, and

each certificate represents a set number of shares. The total

number of shares will vary from one company to another, as each

10

makes its own choice about how many pieces of ownership to divide

the corporation into. One corporation may have only 2,500 shares,

while another, such as IBM or the Ford Motor Company, may issue

over a billion Shares. Companies sell stock (pieces of ownership) to

raise money and provide funding for the expansion and growth of

the business. The business founders give up part of their ownership

in exchange for this needed cash. The expectation is that even

though the owners have surrendered a portion of the company to

the Public, their remaining share of stock will become increasingly

valuable as the business grows. Corporations are not allowed to sell

shares of stock on the open Stock market without the approval of

the Securities and Exchange Commission (SEC). This transition from

a privately held corporation to a publicly traded one is called going

public, and this first sale of stock to the public is called an initial

public offering, or IPO.

Why do people invest in the stock market?

When you buy stock in a corporation, you own part of that

company. This gives you a vote at annual shareholder meetings,

and a right to a share of future profits. When a company pays out

profits to the shareholder, the money received is called a

"Dividend". The corporation's board of directors choose when to

declare a dividend and how much to pay. Most older and larger

companies pay a regular dividend; most newer and smaller

to sell. The potential of a small dividend check is of little concern.

What is usually responsible for increased interest in a company's

11

stock is the prospect of the company's sales and profits going up. A

company who is a leader in a hot industry will usually see its share

price rise dramatically. Investors take the risk of the price falling

because they hope to make more money in the market than they

can with safe investments such as bank CD's or government bonds.

What is a stock market index?

In the stock market world, you need a way to compare the

movement of the market, up and down, from day to day, and from

year to year. An index is just a benchmark or yardstick expressed as

a number that makes it possible to do this comparison. For e.g. S&P

CNX Nifty is the index of NSE and SENSEX is the index of BSE. The

price per share, like the market cap, has nothing to do with how big

a company is.

The Securities Market consists of two segments, viz. Primary

market and Secondary market. Primary market is the place where

issuers create and issue equity, debt or hybrid instruments for

subscription by the public; the Secondary market enables the

holders of securities to trade them. Secondary market essentially

comprises of stock exchanges, which provide platform for purchase

and sale of securities by investors. In India, apart from the Regional

StockExchanges established in different centers, there are exchanges like

the National Stock Exchange (NSE) and the Over the Counter Exchange

of India (OTCEI), who provide nation wide trading facilities with

terminals all over the country. The trading platform of stock exchanges is

12

accessible only through brokers and trading of securities is confined only

to stock exchanges.

Corporate Securities:

The no of stock exchanges increased from 11 in 1990 to 23 now. All the

exchanges are fully computerized and offer 100% on- line trading. 9644

companies were available for trading on stock exchanges at the end of

March 2002. The trading platform of the stock exchanges was accessible

to 9687 members from over 400 cities on the same date

Derivatives Market:

Derivatives trading commenced in India in June 2000. The total

exchange traded derivatives witnessed a volume of Rs. 442,343 crore

during 2002-03 as against Rs. 4018 crore during the preceding year.

While NSE accounted for about 99.5% of total turnover, BSE accounted

for about 0.5% in 2002-03. The market witnessed higher volumes from

June 2001 with introduction of index options, and still higher volumes

with introduction of stock options in July 2001. There was a spurt in

volumes in November 2001 when stock futures were introduced. It is

believed that India is the largest market in the world for stock futures.

Supply and Demand

A stock's price movement up and down until the end of the

trading day is strictly a result of supply and demand. The supply is

the number of shares offered for sale at anyone one moment. The

Demand is the number of shares investors wish to buy at exactly

that same time. What a share of a company is worth on anyone day

or at any one minute, is determined by all investors voting with their

money. If investors want a stock and are willing to pay more, the

13

price will go up. If investors are selling a stock and there aren't

enough buyers, the price will go down Period.

Secondary Market Intermediaries

Stock brokers, sub-brokers, portfolio managers, custodians,

share transfer agents constitute the important intermediaries in the

Secondary Market. No stockbrokers or sub-brokers shall buy, sell or

deal in securities unless he holds a certificate of registration granted

by SEBI under the Regulations made by SEBI ion relation to them.

The Central Government has notified SEBI (Stock Brokers & Sub-

Brokers) Rules, 1992 in exercise of the powers conferred by section

29 of SEBI Act, 1992. These rules came into effect on 20th August,

1992

Trading Through Brokers / Traditional Method of Share Trading:-

Trading in the stock exchange can be conducted only through

member broker in securities that are listed on the respective

exchange. Investor intending to buy/sell securities in the exchange

has to do so only through a SEBI registered broker/sub-broker. This

is very popular concept in India for Share Trading before the

facilities like on line trading introduce. Both the exchange have

switched over from the open outcry trading system to fully

automated computerized mode of trading knows as Bolt and Neat.

In this system, the broker trade with each other through the

computer network. Buyers and sellers place their orders specifying

the limits for quality and price. Those that are not matched remain

on the screen and is opened for future matching during the day /

settlement. After the advent of computerized trading the speed of

14

trading has increased multi-fold and a fuller view of the market is

available to the investors. To start dealing with broker you have to

fill a form with the broker. After fill all the formalities the firm gives

you a User Id no like a bank a/c no. through which you can enter in

the transaction with broker. Broker will gives all the which one

investor needed.

What is stock Broker?

“A stock broker is one who invests other people’s money until it’s all

gone.”

-Woody Allen, American Film Maker

A stock broker is a person or a firm that trades on its clients behalf,

you tell them what you want to invest in and they will issue the buy

or sell order. Some stock brokers also give out financial advice that

you a charged for. It wasn’t too long ago and investing was very

expensive because you had to go through a full service broker

which would give youadvice on what to do and would charge you a

hefty fee for it. There are three different types of stock brokers.

Full Service Broker - A full-service broker can provide a bunch of

services such as investment research advice, tax planning and

retirement planning.

Discount Broker – A discount broker let’s you buy and sell stocks

at a low rate but doesn’t provide any investment advice.

Direct-Access Broker- A direct access broker lets you trade directly

with the electronic communication networks (ECN’s) so you can

trade faster. Active traders such as day traders tend to use Direct

Access Brokers.

15

No. of stock broker in India

9368 :- Total no of share broker in the country

12687 :- The no. of sub-broker.

46% :- The share of trades accounted for by NSE broker

90%: The share of on line trades clocked by segment’s top five companies

Generally there are two types of trading have been done in India which is

given below:

On line Trading / E – Broking / Modern Method

Trading through Brokers / Traditional method of Share trading.

16

Company’s ProfileAbout the Company

MSB e_Trade Securities Limited. (MSB e-Trade) was incorporated in the

year of 1993, The company reached their strength in financial market by

the great effort of the Director of the company Mr. Munish Bajaj. MSB e-

Trade looks forward to tougher challenges and newer milestone to

conquer for get nothing less than the best. MSB e-Trade group providing

the trading platform Equities, Derivatives, Currency, IPOs, Mutual Fund,

Depository Services of NSDL(Launching Shortly) and Commodities (By

its group company) to raising the graph of your savings.

Team

MSB e-Trade group managed by a team of young professionals of

Chartered Accountant, Cost Accountants, Company Secretaries, MBAs,

Technicals  and the other senior executives in Stock Broking, Future &

Options Trading, Currency Trading, Depository Services (Launching

Shortly), IPOs, Mutual Funds Services and Commodities Trading (by its

group company).

Membership

MSBe_tradeSecurities is Member of National Stock Exchange (NSE) for

Capital Market, Future & Option, Currency Derivative Segment Member

of MCX Stock Exchange (MCX-SX) for Currency Derivative

Segment.Awaiting for the Members of UnitedStockExchange of India

Ltd.   (USEIL) for Currency Derivative Segment Member of Association

17

of Mutual Fund In India (AMFI) Company is also planning for Depository

Participant with NSDL at the earliest.

Membership of Group Company

Kalyani Commodities Pvt. Ltd. (The Group company of MSB e-Trade)

Member of Multi Commodities Exchange (MCX)

Member of National Commodity & Derivative Exchange (NCDEX)

Member of National Multi Commodity Exchange (NMCE) &

Member of Indian Commodity Exchange (ICEX)

Business Associates

Kalyani Commodities Pvt Ltd. (Member of MCX. NCDEX, NMCE &

ICEX)

Swot Analysis

Strength-:

Understandings of the markets

All financial needs under one roof

Scalable and robust infrastructure

Full fledge research unit comprising of both fundamental &

technical research

Dedicated, Qualified and Loyal staff

Flexible Brokerage charges

Weakness:-

Low Brand Image in the market.

Low Professionalism

18

Low Advertisements

Opportunity:-

Large potential market for delivery and intra-day transactions.

Open interest of the people to enter in to stock market for investing

Attract the customers who are dissatisfied with other brokers & DPs.

Up growing markets in commodity and forex trading

Threats:-

Decreasing rates of brokerage in the market. A Increasing competition

against other brokers & DPs.

Poor marketing activities for making the company known among the

customers. A threat of loosing clients for any kind of weakness of the

company. An Indirect threat from instable stock market, i.e., low/no

profit of MSB e_trade's clients would lead them to go for other

broker/DP

Services Provided by MSB e_trade securities

Equity and Derivative

MSB e-Trade provides online & offline trading facilities in Equities,

Equities Derivatives & currency Derivatives to the investors on the basis

of live environment who are looking for the ease and convenience of

trading experience. We also provides the trading applications that would

approved by exchange. You can now trade & access from any destination

at your convenience.  Investors may trade through our network or

telephonically by the designated representatives in the branch where you

are registered as a client.    

19

Offline & Online Trading Features

Live trading in a fraction of a second.

Support by the executive.

Quick order punching.

Quick trade confirmation.

Live streaming quoted. Price watch on any number of scripts.

Online trading.

Online access of accounts and DP.

Set any number of price alerts on any number of scripts.

Flexibility to customize screen layout and setting.

Facility to customize any number of portfolios & watch lists.

Facility to cancel all pending orders at one click.

Facility to square off all transactions at one click.

Top Gainers, Top losers, Most Active, updated live.

Index information; index chart, index stock information live.

Market depth, i.e. Best 5 bids and offers, updated live for all scripts

Facility to place orders on the phone in all major cities.

Commodities

Kalyani Commodities Pvt. Ltd. (the group company of MSB e-Trade) is a

member Multi Commodity Exchange   (MCX), National Commodity and

Derivative Exchange (NCDEX), National Multi Commodity Exchange

(NMCE) & Indian Commodity Exchange (ICEX). We are providing the

trading platform in commodities derivative.

Online Trading      

20

MSB e-Trade providing the online trading facilities to the investors

through the platform approved by the exchange on free of cost

Mutual Fund and IPO

Distribution of Mutual fund & IPO MSB e-Trade registered with

Association of Mutual Fund in India (AMFI) for providing the Mutual

Fund services in India. We are also providing the online mutual fund

activities through National Stock Exchange (NSE). We also providing the

IPOs services through leading distributors of IPOs.

Depository

We are launching shortly the Depository Services to the investor.

Back Office

MSB e-Trade Providing the Bank office facility to the client registered

with us. Client can check the financial & securities details held in their

name. You can access or print the financial statement, Holding statement

etc. by the login id and password issue by the authority to the client at the

time opening of their trading account.

Products

Equities & Derivative

Currency Derivative

Commodities Derivative

Mutual Fund

IPO

21

Offline

Offline A/C is the A/C for the investors who are not familiar with the

use of computer.

The A/C opening Charges applied (One time).

For 1st Year Demat A/c is free , On 2nd year AMC charge is

applicable.

Online Account Requirements for online trading

Linked Bank account

Broking Account

Linked Depository Account

Benefits of online trading

Freedom from paperwork

Instant credit and transfer

Trade Anywhere

Timely Advice and access to research

Real-time portfolio tracking

After hour orders

Market Alerts

Instant Quotes

Other services

Dial-n-trade

Mutual fund

22

Commodity

Derivative

Depository Participants

Distribution of Financial Services

Research Based Advices

Portfolio Management System

Portofolia management System

DnT (Dial-n-Trade)

Dial n Trade is the name of the phone-trading facility offered by MSB

e_trade securities.

A call center wholly dedicated to order placement / confirmation

Easy 2-step process for order placement.

Step1. Enter your Phone ID

Step2. Enter your Client Code

On successful dial, call gets transferred to call center executives. MSB

e_trade Securities Private Limited, one of the cornerstones of the MSB

edifice, flows freely towards attaining diverse goals of the customer

through varied services. Creating a plethora of opportunities for the

customer by opening up investment vistas is backed by research-based

advisory services. Here, growth knows no limits and success recognizes

no boundaries. Helping the customer create waves in his portfolio and

empowering the investor completely is the ultimate goal.

Stock Broking Services

We offer trading on a vast platform; National Stock Exchange, Bombay

Stock Exchange, MCX & NCDEX. More importantly, we make trading

23

safe to the maximum possible extent, by accounting for several risk

factors and planning accordingly. We are assisted in this task by our in-

depth research, constant feedback and sound advisory facilities. Our

highly skilled research team, comprising of technical analysts as well as

fundamental specialists, secure result- oriented information on market

trends, market analysis and market predictions.

To empower the investor further we have made serious efforts to ensure

that our research calls are disseminated systematically to all our stock

broking clients through various delivery channels like email, chat, SMS,

phone calls etc.

Mutual Funds

Introduction:

Everybody talks about mutual funds, but what exactly are they? Are they

like shares in a company, or are they like bonds and fixed deposits? Will I

lose all my money in funds or will I become an overnight millionaire? Big

questions that get answer in just five minutes.

Meaning:

A mutual fund is a pool of money that is invested according to a common

investment objective by an asset management company (AMC). The

AMC offers to invest the money of hundreds of investors according to a

certain objective – to keep money liquid or give a regular income or grow

the money long term. Investors buy a scheme if it fits in with their

investment goals, like getting a regular income now or letting the money

accumulate over the long term. Investors pay a small fraction of their total

funds to the AMC each year as investment management fees.

24

Commodity

Organized futures market evolved in India by the setting up of "Bombay

Cotton Trade Association Ltd." in 1875. In 1893, following widespread

discontent amongst leading cotton mill owners and merchants over the

functioning of the Bombay Cotton Trade Association, a separate

association by the name "Bombay Cotton Exchange Ltd." Was

constituted. A future trading in oilseeds was organized in India for the

first time with the setting up of Gujarati Vyapari Mandali in 1900, which

carried on futures trading in groundnut, castor seed and cotton. Before the

Second World War broke out in 1939 several futures markets in oilseeds

were functioning in Gujarat and Punjab. There were booming activities in

this market and at one time as many as 110 exchanges were conducting

forward trade in various commodities in the country.

The securities market was a poor cousin of this market as there were not

many papers to be traded at that time. The era of widespread shortages in

many essential commodities resulting in nflationary pressures and the tilt

towards socialist policy, in which the role of market forces for resource

allocation got diminished, saw the decline of this market since the mid-

1960s.

This coupled with the regulatory constraints in 1960s, resulted in virtual

dismantling of the commodities future markets. It is only in the last

decade that commodity future exchanges have been actively encouraged.

However, the markets have been thin with poor liquidity and have not

grown to any significant level.

Conceptual DiscussionDerivative

25

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.

Depository Participants

The onset of the technology revolution in financial services Industry saw

the emergence of MSB as an electronic custodian registered with National

Securities Depository Ltd (NSDL) and Central Securities Depository Ltd

(CSDL). M S B set standards enabling further comfort to the investor

by promoting paperless trading across the country and emerged as the top

3 Depository Participants in the country in terms of customer serviced.

Offering a wide trading platform with a dual membership at both NSDL

and CDSL, we are a powerful medium for trading and

settlement of dematerialized Shares. We have established live

DPMs, Internet access to accounts and an easier transaction process in

order to offer more convenience to individual and corporate investors. A

team of professional and the latest technological expertise allocated

exclusively to our demat division including technological enhancements

26

like Speed-e; make our response time quick and our delivery impeccable.

A wide national network makes our efficiencies accessible to all.

Portfolio Management System

The company has initiated the process of obtaining permission from SEBI

for rendering PMS Service to its clients. We are planning to start PMS

Service to High Net Worth individual and NRIs after obtaining the

necessary regulatory clearances

Theoretical Aspect

Introduction:

According to dictionary, derivative means ‘something which is derived

from another source’. Therefore, derivative is not primary, and hence not

independent. In financial terms, derivative is a product whose value is

derived from the value of one or more basic variables. These basic

variable are called bases, which may be value of underlying asset, a

reference rate etc. the underlying asset can be equity, foreign exchange,

commodity or any asset.

For example: - the value of any asset, say share of any company, at a

future date depends upon the share’s current price. Here, the share is

underlying asset, the current price of the share is the bases and the future

value of the share is the derivative. Similarly, the future rate of the foreign

exchange depends upon its spot rate of exchange. In this case, the future

exchange rate is the derivative and the spot exchange rate is the base.

Derivatives are contract for future delivery of assets at price agreed at the

time of the contract. The quantity and quality of the asset is specified in

27

the contract. The buyer of the asset will make the cash payment at the

time of delivery.

Meaning:

Derivatives are the financial contracts whose value/price is dependent on

the behavior of the price of one or more basic underlying assets (often

simply known as the underlying). These contracts are legally binding

agreements, made on the trading screen of stock exchanges, to buy or sell

an asset in future.

The asset can be a share, index, interest rate, bond, rupee dollar exchange

rate, sugar, crude oil, soybean, cotton, coffee etc. In the Indian Context the

Security Contracts (Regulation) Act, 1956 (SC(R) A) defines “derivative”

to include – A security derived from a debt instrument, share, loan

whether secured or unsecured, risk instrument or contract for differences

or other form of security.

In financial terms derivatives is a broad term for any instrumental

whose value is derived from the value of one more underlying

assets such as commodities, forex, precious metal, bonds, loans,

stocks, stock indices, etc. Derivatives were developed primarily to manage

offset, or hedge against risk but some were developed primarily to provide

potential for high returns. In the context of equity markets, derivatives

permit corporations and institutional Investors to effectively manage their

portfolios of assets and liabilities through instrument like stock index

futures.

For example: - The price of Reliance Triple Option Convertible

Debentures (Reliance TOCD) used to vary with the price of Reliance

28

shares. In addition, the price of Telco warrants depends upon the price of

Telco shares. American Depository receipts / Global Depository receipts

draw their price from the underlying shares traded in India. Nifty options

and futures. Reliance futures and options, are the most common and

popular form of derivatives. Although trading in agriculture and other

commodities has been the deriving force behind the development of

derivatives exchanges, the demand for products based on financial

instruments such as bond, currencies, stocks and stock indices have now

for outstripped that for the commodities contracts. The history of the

derivatives dates back to the time since the trading came into being. The

merchants entered into contracts with one another for future delivery of

specified amount of commodities at specified price. A primary intention

for contracting for future date was to keep the transaction immune to

unexpected fluctuations in price. Therefore, derivative products initially

emerged as hedging devices against fluctuations in commodity prices.

However, the concept applied to financial trade only in the post-1970

period due to growing instability in the financial markets. However, since

their emergence, these products have become very popular and by 1990s,

they accounted for about two-third of the total transaction in derivative

products.

In recent years, the market for financial derivatives has grown

tremendously in terms of variety of instruments available, their

complexity and turnover. In the class of equity derivatives the world over,

futures and options on stock indices have gained more popularity than on

individual stocks, especially among institutional investors, who are major

users of index-linked derivatives. Even small investors find these useful

29

due to high correlation of the popular indexes with various portfolios and

ease of use.

Early forward contracts in the US addressed merchants concerns about

ensuring that there were buyers and sellers for commodities. However

“credit risk” remained a serious problem.

1848

A group of Chicago businessmen formed the Chicago Board of Trade

(CBOT). The primary intention of the CBOT was to provide a centralized

location known in advance for buyers and sellers to negotiate forward

contracts.

1865

The CBOT went one-step further and listed the first “exchange traded”

derivatives contract in the US; these contracts were called “future

contracts”

1919

Chicago Butter and Egg & board, a spin-off of CBOT, was reorganized to

allow futures trading. Its name was changed to Chicago Mercantile

Exchange (CME).

The CBOT and the CME remain the two largest organized futures

exchanges, indeed the two largest “financial” exchanges of any kind in the

world today.

The first stock index futures contract was traded at Kansas City Board of

Trade. Currently the most popular stock index futures contract in the

world was based on S&P 500 index, traded on Chicago Mercantile

Exchange. During the mid eighties, financial futures became the most

active derivatives instruments generating volumes many times more than

30

the Commodity futures. Index futures, futures on T-Bills and Euro-Dollar

futures are the three most popular future contracts traded today. Other

popular international exchanges that trade derivatives are LIFFE in

England, DTB in Germany, SGX in Singapore, TIFFE in Japan, and

MATIF in France, Eurex, etc. India has been trading derivatives contract

in silver gold, spices, coffee, cotton, etc for decades in the gray market.

Trading derivatives contracts in organized market was legal before

Moorage Desai’s government banned forward conracts. Derivatives on

stocks were traded in the form of Teji and Mandi in unorganized on

exchanges. For example, now cotton and oil futures trade in Mumbai,

soybean futures trade in Bhopal, pepper futures in Kochi, coffee in

Bangalore, etc.

June 2000

National Stock Exchange and Bombay Stock Exchange started trading in

futures on Sensex and Nifty. Options trading on Sensex and Nifty

commenced in June 2001. Very soon thereafter trading began on options

and futures in 31 prominent stocks in the month of July and November

respectively.

Option and future are the most commonly traded derivatives, but as the

understanding of financial markets and risked management

continued to improve newer derivatives were created. The family includes

the host of other product such as forward contracts. Structured notes,

inverse floaters, caps & Floors and Collar Swaps. The largest derivatives

market in the world, are on government bonds (to help control interest rate

risk) the stock index (to help control risk that is associated with the

31

fluctuations in the stock market) and on exchange rates (to cope with

currency risk).

Risk Associated With Derivatives:

While derivatives can be used to help manage risks involved in

investments, they also have risks of their own. However, the risks

involved in derivatives trading are neither new nor unique – they are the

same kind of risks associated with traditional bond or equity instruments.

Market Risk

Derivatives exhibit price sensitivity to change in market condition, such as

fluctuation in interest rates or currency exchange rates. The market risk of

leveraged derivatives may be considerable, depending on the degree of

leverage and the nature of the security.

Liquidity Risk

Most derivatives are customized instrument and could exhibit

substantial liquidity risk implying they may not be sold at a reasonable

price within a reasonable period. Liquidity may decrease

or evaporate entirely during unfavorable markets.

Credit Risk

Derivatives not traded on exchange are traded in the over-the- counter

(OTC) market. OTC instrument are subject to the risk of counter party

defaults.

Hedging Risk

Several types of derivatives, including futures, options and forward are

used as hedges to reduce specific risks. If the anticipated risks do not

develop, the hedge may limit the fund’s total return.

32

The derivative market performs a number of economic functions:-

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. The prices of derivative converge with the

prices of the underlying at the expiration of the derivative contract. Thus,

derivatives help in discovery of future as well as current prices.

The derivatives market helps to transfer risks from those who have them

but may not like them to those who have an appetite for them.

Derivatives, due to their inherent nature, are linked to the

underlying cash market. With the introduction of the derivatives, the

underlying market witnesses higher trading volumes because of the

participation by more players who would not otherwise participate for

lack of arrangement to transfer risk.

Speculative trades shift to a more controlled environment of derivatives

market. In the absence of an organized derivative market, speculators

trade in the underlying cash market.

An important incidental benefit that flows from derivatives trading is

that it acts as a catalyst for new entrepreneurial activity.

The derivatives have a history of attracting many bright, creative,

well educated people with an entrepreneurial attitude. They often

energize others to create new businesses, new products and new

employment opportunities, the benefit of which are immense.

Derivatives markets help increase savings and investment in the end.

Transfer of risk enables market participants to expand their volumes of

activity.

33

Participants of Derivative Market:-

Market participants in the future and option markets are many and they

perform multiple roles, depending upon their respective positions. A

trader acts as a hedger when he transacts in the market for price risk

management. He is a speculator if he takes an open position in the price

futures market or if he sells naked option contracts. He acts as an

arbitrageur when he enters in to simultaneous purchase and sale of a

commodity, stock or other asset to take advantage of mispricing. He earns

risk less profit in this activity. Such opportunities do not exist for long in

an efficient market. Brokers provide services to others, while market

makers create liquidity in the market.

Hedgers

Hedgers are the traders who wish to eliminate the risk (of price change) to

which they are already exposed. They may take a long position on, or

short sell, a commodity and would, therefore, stand to lose should the

prices move in the adverse direction.

Speculators

If hedgers are the people who wish to avoid the price risk, speculators are

those who are willing to take such risk. These people take position in the

market and assume risk to profit from fluctuations in prices. In fact,

speculators consume information, make forecasts about the prices and put

their money in these forecasts. In this process, they feed information into

prices and thus contribute to market efficiency. By taking position, they

34

are betting that a price would go up or they are betting that it would go

down.

The speculators in the derivative markets may be either day trader

or position traders. The day traders speculate on the price movements

during one trading day, open and close position many

times a day and do not carry any position at the end of the day.

They monitor the prices continuously and generally attempt to make profit

from just a few ticks per trade. On the other hand, the position traders also

attempt to gain from price fluctuations but they keep their positions for

longer durations may is for a few days, weeks or even months.

Arbitrageurs

Arbitrageurs thrive on market imperfections. An arbitrageur profits by

trading a given commodity, or other item, that sells for different prices in

different markets. The Institute of Chartered Accountant of India, the

word “ARBITRAGE” has been defines as follows:-

“Simultaneous purchase of securities in one market where the price there

of is low and sale thereof in another market, where the price thereof is

comparatively higher. These are done when the same securities are being

quoted at different prices in the two markets, with a view to make profit

and carried on with conceived intention to derive advantage from

difference in prices of securities prevailing in the two different markets”

Thus, arbitrage involves making risk- less profits by simultaneously

entering into transactions in two or more markets.

Types of derivatives:-

35

The most commonly used derivatives contracts are Forward, Futures and

Options. Here some derivatives contracts that have come to be used are

covered.

Forward:-

A forward contract is a customized contract between two entities, where

settlement takes place on a specific date in the future at today’s pre agreed

price.

Futures :-

A futures contact is an agreement between two parties to buy or sell

an asset at a certain time in the future at a certain price. Futures

contracts are special types of forward contracts in the sense that

the former are standardized exchange-traded contracts For example: - A,

on 1 Aug. agrees to sell 600 shares of Reliance Ind.Ltd. @ Rs. 450 to B

on 1st sep. A, on 1st Aug. agrees to buy 600 shares of Reliance Ind. Ltd.

@ Rs. 450 to B on 1st Sep.

Options:-

Options are a right available to the buyer of the same, to purchase or sell

an asset, without any obligation. It means that the buyer of the option can

exercise his option but is not bound to do so. Options are of 2 types: calls

and puts.

Calls:-

Call gives 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.

For example :- A, on 1st Aug. buys an option to buy 600 shares of

Reliance Ind. Ltd. @ 450 Rs 450 on or before 1st Sep. In this case, A has

36

the right to buy the shares on or before the specified date, but he is not

bound to buy the shares.

Puts:-

Put gives 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. For example :- A, on 1st Aug. buys an option to sell 600 shares of

Reliance Ind. Ltd. @ Rs 450 on or before 1st Sep. In this case, A has the

right to sell the shares on or before the specified date, but he is not bound

to sell the shares. In both the types of the options, the seller of the option

has an obligation but not a right to buy or sell an asset. His buying or

selling of an asset depends upon the action of buyer of the option. His

position in both the type of option is exactly the reverse of that of a buyer.

Warrants :-

Options generally have lives of up to one year, the majority of options

exchanges having a maximum maturity of nine months. Longer-dated

options are called warrants and are generally traded over-the-counter.

Leaps :-

The acronym LEAPS means Long-Term Equity Anticipation Securities.

These are options having a maturity of up to three years.

Basket :-

Basket options are options on portfolios of underlying assets are usually a

moving average of a basket of assets. Equity index options are a form of

basket options.

Swaps :-

37

Swaps are private agreement between two parties to exchange cash flows

in the future according to a pre arranged formula. They can be regarded as

portfolios of forward contract. The two commonly used swaps are as

follows :

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.

Swaptions :-

Swaptions are options to buy or sell a swap that will become operative at

the expiry of the options. Thus, a swaptions is an option on a forward

swap. Rather than have calls and puts, the swaptions market has receiver

swaptions and payer swaptions. A receiver swaptions is an option to

receive fixed and pay floating. A payer swaptions is an option to pay fixed

and receive floating Out of the above-mentioned types of derivatives

forward.

Emergence of Derivative Trading in India

Approval For Derivatives Trading

The first step towards introduction of derivatives trading in India was the

promulgation of the Securities Laws (Amendment) Ordinance, 1995,

which withdrew the prohibition on options in securities. The market for

derivatives, however, did not take off, as there was no regulatory

38

framework to govern trading of derivatives. SEBI set up a 24 – member

committee under the chairmanship of Dr. L.C.Gupta on November 18,

1996 to develop appropriate regulatory framework for derivatives trading

in India. The committee submitted its report on March 17, 1998

prescribing necessary pre- conditions for introduction of derivatives

trading in India.

The committee recommended that derivatives should be declared as

‘securities’ so that regulatory framework applicable to trading of

‘securities’ could also govern trading of securities. SEBI also set up a

group in June 1998 under the chairmanship of Prof. J.R.Verma, to

recommend measures for risk containment in derivative market in India.

The repot, which was submitted in October 1998, worked out the

operational details of margining system, methodology for charging initial

margins, broker net worth, deposit requirement and real - time monitoring

requirements.

The SCRA was amended in December 1999 to include derivatives within

the ambit of ‘securities’ and the regulatory framework were developed for

governing derivatives trading. The act also made it clear that derivatives

shall be legal and valid only if such contracts are traded on a recognized

stock exchange, thus precluding OTC derivatives. The government also

rescinded in March 2000, the three – decade old notification, which

prohibited forward trading in securities.

Derivatives trading commenced in India in June 2000 after SEBI granted

the final approval to this effect in May 2000. SEBI permitted the

derivative segment of two stock exchanges, NSE and BSE, and their

39

clearing house/corporation to commence trading and settlement in

approved derivatives contract.

To begin with, SEBI approved trading in index future contracts based on

S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by

approval for trading in options based on these two indices and options on

individual securities. The trading in index options commenced in June

2001. Futures contracts on individual stocks were launched in November

2001. Trading and settlement in derivatives contracts are done in

accordance with the rules, bye laws, and regulations of the respective

exchanges and their clearing house/corporation duly approved by SEBI

and notified in the official gazette.

Introduction to forward Contracts:-

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 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. The parties to the contract

negotiate other contracts details like delivery date, price, and

quantity bilaterally. The forward contracts are normally traded

outside the exchanges.

Salient features of forward contracts are as follows:-

They are bilateral contracts and hence exposed to counter party risk.

40

Each contract is custom designed, and hence is unique in terms of

contract size, expiration date and the asset type and quality.

The contract price is generally not available in public domain

On the expiration date, the contract has to be settled by delivery of

the asset.

If the party wishes to reverse the contract, it has to compulsorily go

to the same counter party, which often results in high prices being

charged.

Limitation of forward market

Forward market worldwide is affected by several problems:-

Lack of centralization.

Illiquidity.

Counter party risk

In the first two of these, the basic problem is that of too much flexibility

and generality. The forward market is like a real estate market in that any

two consenting adults can form contracts against each other. This often

makes them design terms of the deal, which are very convenient in that

specific situation, but makes the contract non-tradable.

Counter party risk arises from the possibility of default by any one party

to the transaction. When one of the two sides to the transaction declares

bankruptcy, the other suffers. Even when forward markets trade

standardized contracts, and hence avoid the problem illiquidity, the

counter party risk remains a very serious.

41

Introduction to Futures:-

Future contract is specie of forward contract. Futures are exchange- traded

contracts to sell or buy standardized financial instruments or physical

commodities for delivery on a specified date at an agreed price. Futures

contracts are used generally for protecting against rich of adverse price

fluctuations (hedging). As the terms of contracts are standardized, these

are generally not used for merchandizing purpose.

The standardized items in a futures contract are:

Quantity of the underlying.

Quality of the underlying.

The date and month of delivery.

The units of price quotation and minimum price change.

Location of settlement.

Futures contract performs two important functions of price discovery and

price risk management with reference to the given commodity. It is useful

to all segment of economy. It is useful to the producer because investor

can get an idea of the price likely to prevail at a future point of time and

therefore can decide between various competing commodities, the best

that suits him. It enables the consumer get an idea of the price at which the

commodity would be available at a future point of time. He can do proper

costing and cover his purchases by making forward contracts. The future

trading is very useful to the exporters as it provides an advance indication

of the price likely to prevail and thereby help the exporter in quoting a

realistic price and thereby secure export contract in a competitive market.

Having entered into an export contract, it enables him to hedge his risk by

operating in futures market.

42

Other benefits of futures trading are:

Price stabilization in time of violent price fluctuations- this

mechanism dampens the peaks and lifts up the valleys i.e. the

amplitude of price variation is reduced.

Leads to integrated price structure throughout the country.

Facilitates lengthy and complex, production and manufacturing

activities.

Helps balance in supply and demand position throughout the year.

Encourages competition and acts as a price barometer to farmers

and other trade functionaries.

FEATURE FORWARD

CONTRACT

FUTURE

CONTRACT

OPERATIONAL

MECHANISM

Traded Directly

between two parties

(not traded on the

exchanges)

Traded on the

exchanges

CONTRACT

SPECIFICATIONS

Differ from trade to

trade.

Contracts are

standardised

contracts

COUNTER PARTY

RISK

Exists Exists. However by

the clearing Corp.,

which becomes the

counter party to all

trades or

uncontionally

43

guarantees their

settlement.

LIQUIDATION

PROFILE

Low, as contracts are

tailor made contracts

catering to the needs

of the parties.

High, as contracts are

standardised

exchange traded

contracts.

PRICE

DISCOVERY

Not efficient, as

markets are scattered.

Efficient as markets

are centralized and all

buyers and sellers

come to a common

platform to discover

the price.

Margins

The margining system is based on the J R Verma committee

recommendations. The actual margining happens on a daily basis

while online position monitoring is done on an intra day basis. Daily

margining is of two types:

Initial margins.

Mark-to market profit/loss.

The computation of initial margin on the futures market is done using the

concept of Value-at-risk (VaR). The initial margin amount is large enough

to cover a one-day loss that can be encountered on 99% of the days. VaR

methodology seeks to measure the amount of value that a portfolio may

stand to lose within certain horizon period (one day for the clearing

44

corporation) due to potential changes in the underlying asset market price.

Initial margin amount computed using VaR is collected up-front. The

daily settlement process called “mark-to-market” provides for collection

of losses that have already occurred (historic losses) whereas initial

margin seeks to safeguard against potential losses on outstanding

positions. The mark-to- market settlement is done in cash.

Settlement of Future Contract:-

Futures contract has two types of settlement, the MTM settlement, which

happens on a continuous basis at the end of each day, and the final

settlement, which happens on the last trading day of the futures contract.

MTM Settlement

All futures contact for each member is marked-to-market (MTM) to the

daily settlement price of the relevant futures contract at the end of each

day. The profits/losses are computes as a difference between:

The trade price and the day’s settlement price for contracts

executed during the day but not squared up.

The previous day’s settlement price and the current day’s

settlement price for brought forward contracts.

The buy price and the sell price for the contracts executed during the day

and squared up. The clearing members (CMs) who have a loss are

required to pay the mark-to-market (MTM) loss amount in cash which is

in, turn passed on to the CMs who have made a MTM profit. This is

known as daily mark-to-market settlement. CMs are responsible to collect

and settle the daily MTM profits/losses incurred by the Trading members

(TMs) and their clients clearing and settling through them. Similarly, TMs

are responsible to collect/pay/losses/profits from/to their clients by the

45

next day. The pay-in and payout of the mark-to-market settlement are

affected on the day following the trade day. After completion of daily

settlement computation, all the open positions are reset to the daily

settlement price. Such position becomes the opening positions for the next

day.

Final settlement for futures

On the expiry of the future contracts, after the close of trading hours,

NSCCL marks all positions of CM to the final settlement price and the

resulting profits/losses is settled in cash. Final settlement loss/profits

amount is debited/credit to the relevant CM’s clearing bank account on

the day following expiry day of the contract

Settlement price for futures:-

Daily settlement price on a trading day is the closing price of the

respective future contracts on such day. The closing price for the future

contracts is currently calculated as the last half an hour weighted average

price of a contract in the F&O segment of NSE. Final settlement price is

the closing price of the relevant underlying index/security in the capital

market segment of NSE, on the last trading day of the contract. The

closing price of the underlying Index/security is currently its last half an

hour weighted average value in the capital market segment of NSE.

Introduction to options-:

46

Options give the holder or buyer of the option the right to do

something. If the option is a call option, the buyer or holder has the right

to buy the number of shares mentioned in the contract at the agreed strike

price. If the option is a put option, the buyer of the option has a right to

sell the number of shares mentioned in the contract at the agreed strike

price. The holder of the buyer does not have to exercise this right.

Thus on the expiry of the day of the contract the option may or may not be

exercised by the buyer. In contrast, in a futures contract, the two parties to

the contract have committed themselves to doing something at a future

date. To have this privilege of doing the transaction at a future only if it is

a profitable, the buyer of the option has to pay a premium to the seller of

options.

Types of options:-

An option is a contract between two parties giving the taker/buyer)

the right, but not obligation, to buy or sell a parcel of shares at a

predetermined price possibly on, or before a predetermined rate. To

acquire this right the taker pays a premium to the writer (seller) of

the contract.

There are two types of options:

Call Options

Put Options

Call Options:

Call options give the taker the right, but not the obligation, to buy

the underlying shares at a predetermined price, on or before a

predetermined date. Call Options- Long & Short Positions

47

When you expect prices to rise, then you take a long position by

buying calls. You are bullish. When you expect prices to fall, then

you take a short position by selling calls. You are bearish.

Put Options:

A Put Option gives the holder of the right to sell a specific number of an

agreed security at a fixed price for a period. Put Options- Long & Short

Positions When you expect prices to rise, then you take a long position by

buying Puts. You are bearish.

When you expect prices to fall, then you take a short position by selling

Puts. You are bullish.

Particulars Call Options Put Options

If you expect a fall in price [Bearish] Short Long

If you expect a rise in price [Bullish] Long Short

TABLE SHOWING THE DEALING OF CALL & PUT OPTION

Call option Holder (buyer) Call option Writer (seller)

Pays premium

Right to exercise and buy

shares

Profit from rising prices

Limited losses, potentially

unlimited gains.

Receives Premium

Obligations of sell shares if

exercised

Profits from falling prices or

remaining neutral

Potentially unlimited losses ,

limited gains

Put option Holder (buyer) Put option Writer ( seller)

Pays premium Receives Premium

48

Right to exercise and buy

shares

Profit from rising prices

Limited losses , potentially

unlimited gains.

Obligations of sell shares if

exercised

Profits from rising prices or

remaining neutral

Potentially limited losses ,

limited gains

Important Concepts:-

In -the- money option:

It is an option with intrinsic value. A call option is in the memory if the

underlying price is above the strike price. A put option is in the memory if

the underlying price is below the strike price.

Out- of- the- money:

It is an option that has no intrinsic Value, i.e. all of its value consists of

time value. A call option is out of the money if the stock price is below its

strike price.

At-the-money:

A term that describes an option with a strike price that is equal to the

current Market price of the underlying stock. But of the money if the stock

price is about its strike price.

Market Scenario Call Option Put Option

Market price > In- the- money Out- of- the- money

49

strike

price

Market price <

strike

price

Out- of- the- money In- the- money

Market price =

strike

price

At- the- money At the- money

Market price ~ strike

price

Near- the- money Near- the- money

Intrinsic Value

In a call option, if the value of the underlying asset is higher than

the strike price, the option premium has an intrinsic value and is an

“in- the- money” option. If the value of the underlying asset is lower

than the strike price, the option has no intrinsic value and is an “out-

of- the- money” option. If the value of the underlying asset is

equivalent to the strike price, the call option is “at- themoney” and

has no intrinsic value or zero intrinsic value.In a put option, if the value of

the underlying asset is lower than the strike price, the option has an

intrinsic

50

value and is an “in- the- money” option. If the value of the underlying

asset is higher than the strike price, the option has no intrinsic value and is

“out- of- money” option. If the value of the underlying asset is equivalent

to the strike price, the put option is at the- money”

Time Value

Time value is the amount an investor is willing to pay for an option, in the

hope that at some time prior to expiration its value will increase because

of a favorable change in the price of the underlying asset. Time value

reduces as the expiration draws near and on expiration day; the time value

of the option is zero.

Option Price

An option cost or price is called “premium”. The potential loss for the

buyer of an option is limited to the amount of premium paid for the

contract. The writer of the option, on the other hand, undertakes the risk of

unlimited potential loss, for premium received. Thus,

Option Price = Premium Price

A premium is the net amount the buyer of an option pays to the seller of

the option. It does not refer to an amount above the base price, as the term

“premium” commonly used. The of an option has two important

constituents, intrinsic value and time value.

Premium = Intrinsic value + Time

Pricing with regard to Options:-

The Black and Scholes Model:

51

The Black and Scholes Option Pricing Model didn't appear overnight, in

fact, Fisher Black started out working to create a valuation model for

stock warrants. This work involved calculating a derivative to measure

how the discount rate of a warrant varies with time and stock price. The

result of this calculation held a striking resemblance to a well-known heat

transfer equation.

Soon after this discovery, Myron Scholes joined Black and the result of

their work is a startlingly accurate option pricing model. Black and

Scholes can't take all credit for their work; in fact their model is actually

an improved version of a previous model developed by A. James Boness

in his Ph.D. dissertation at the University of Chicago. Black and Scholes'

improvements on the Boness

model come in the form of a proof that the risk-free interest rate is the

correct discount factor, and with the absence of assumptions regarding

investor's risk preferences.

Black and Scholes Model:

In order to understand the model itself, we divide it into two parts. The

first part, SN [d1), derives the expected benefit from acquiring a stock

outright. This is found by multiplying stock price [S] by the change in the

call premium with respect to a change in the underlying stock price [N

(d1)]. The second part of the model, Ke [-rt) N (d2), gives the present

value of paying the exercise price on the expiration day. The fair market

value of the call option is then calculated by taking the difference between

these two parts.

Assumptions of the Black and Scholes Model:-

The stock pays no dividends during the option's life

52

Most companies pay dividends to their share holders, so this might seem

a serious limitation to the model considering the observation that higher

dividend yields elicit lower call premiums. A common way of adjusting

the

model for this situation is to subtract the discounted value of a future

dividend from the stock price.

European exercise terms are used

European exercise terms dictate that the option can only be exercised on

the expiration date. American exercise term allow the option to be

exercised at any time during the life of the option, making American

options more valuable due to their greater flexibility. This limitation is not

a major concern because very few calls are ever exercised before the last

few days of their life. This is true because when you exercise a call early,

you forfeit the remaining time value on the call and collect the intrinsic

value. Towards the end of the life of a call, the remaining time value is

very small, but the intrinsic value is the same.

Markets are efficient

This assumption suggests that people cannot consistently predict the

direction of the market or an individual stock. The market operates

continuously with share prices following a continuous into process. To

understand what a continuous into process is, you must first know that a

Markov process is "one where the observation in time period t depends

only on the preceding observation." An into process is simply a Markov

53

process in continuous time. If you were to draw a continuous process you

would do so without picking the pen up from the piece of paper.

No commissions are charged

Usually market participants do have to pay a commission to buy or sell

options. Even floor traders pay some kind of fee, but it is usually very

small. The fees that Individual investor's pay is more substantial and can

often distort the output of the model.

Interest rates remain constant and known

The Black and Scholes model uses the risk-free rate to represent this

constant and known rate. In reality there is no such thing as the risk-free

rate, but the discount rate on U.S. Government Treasury Bills with 30

days left until maturity is usually used to represent it. During periods of

rapidly changing interest rates, these 30-day rates are often subject to

change, thereby violating one of the assumptions of the model.

Returns are log normally distributed

This assumption suggests, returns on the underlying stock are

normally distributed, which is reasonable for most assets that offer

options.

Advantages & Limitations:-

Advantage:

The main advantage of the Black-Scholes model is speed – it lets you

calculate a very large number of option prices in a very short time.

54

Limitation:

The Black-Scholes model has one major limitation: it cannot be

usedto accurately price options with an American-style exercise as

it only calculates the option price at one point in time -- at

expiration. It does not consider the steps along the way where there

could be the possibility of early exercise of an American option.

As all exchange traded equity options have American-style

exercise (i.e. they can be exercised at any time as opposed to

European options which can only be exercised at expiration) this is

a significant limitation.

The exception to this is an American call on a non-dividend paying

asset. In this case the call is always worth the same as its European

equivalent as there is never any advantage in exercising early.

Various adjustments are sometimes made to the Black-Scholes

price to enable it to approximate American option prices but these

only works well within certain limits and they don't really work

well for puts.

Difference between derivative and equity

Warehousing No warehousing is

required

No warehousing is

required

Quality of

underlying

assets

Derivatives contract

don’t have attribute

of quality

Equity contract don’t

have

attribute of quality

Contract life Comparatively Having long and

55

having

long contract life

short

contract life

Maturity date Standardized Standardized

Return High Medium

Risk Very High Less

Liquidity Less Very high

Lot size Fixed by SEBI Not fixed by SEBI

Time of trading 9a.m to 3.30p.m 9a.m to 3.30p.m

Investment

Amount

Very high Low

Regulatory Framework

The trading of derivatives is governed by the provisions contained in the

SC(R)A, the SEBI Act, the rules and regulations framed there under and

the rules and bye–laws of stock exchanges.

Securities Contract (Regulation) Act, 1956

SC(R)A aims at preventing undesirable transactions in securities by

regulating the business of dealing therein and by providing for certain

other matters connected therewith. This is the principal Act, which

governs the trading of securities in India. The term “securities” has been

defined in the SC(R)A. As per Section 2(h), the ‘Securities’ include:

56

Shares, scripts, stocks, bonds, debentures, debenture stock or

other marketable securities of a like nature in or of any

incorporated company or other body corporate.

Derivative

Units or any other instrument issued by any collective

investment scheme to the investors in such schemes.

Government securities

Such other instruments as may be declared by the Central

Government to be securities.

Rights or interests in securities.

“Derivative” is defined 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.

Section 18A provides that notwithstanding anything contained in any

other law for the time being in force, contracts in derivative shall be

legal and valid if such contracts are:

Traded on a recognized stock exchange

Settled on the clearing house of the recognized stock exchange, in

accordance with the rules and bye–laws of such stock exchanges.

Securities and Exchange Board of India Act, 1992

57

SEBI Act, 1992 provides for establishment of Securities and Exchange

Board of India(SEBI) with statutory powers for (a) protecting the interests

of investors in securities (b) promoting the development of the securities

market and (c) regulating the securities market. Its regulatory jurisdiction

extends over corporate in the issuance of capital and transfer of securities,

in addition to all intermediaries and persons associated with securities

market. SEBI has been obligated to perform the aforesaid functions by

such measures as it thinks fit. In particular, it has powers for regulating

the business in stock exchanges and any other securities markets.

registering and regulating the working of stock brokers, sub–brokers etc.

promoting and regulating self-regulatory organizations.

prohibiting fraudulent and unfair trade practices.

calling for information from, undertaking inspection, conducting

inquiries and audits of the stock exchanges, mutual funds and other

persons associated with the securities market and intermediaries and self–

regulatory organizations in the securities market.

performing such functions and exercising according to Securities

Contracts (Regulation) Act, 1956, as may be delegated to it by the

Central Government.

Regulations for derivatives Trading

SEBI set up a 24- member committee under the Chairmanship of Dr. L. C.

Gupta to develop the appropriate regulatory framework for derivatives

trading in India. On May 11, 1998 SEBI accepted the recommendations of

the committee and approved the phased introduction of derivatives trading

in India beginning with stock index futures. The provisions in the SC(R)A

58

and the regulatory framework developed there under govern trading in

securities. The amendment of the SC(R)A to include derivatives within

the ambit of ‘securities’ in the SC(R)A made trading in derivatives

possible within the framework of that Act.

Any Exchange fulfilling the eligibility criteria as prescribed in the L. C.

Gupta committee report can apply to SEBI for grant of recognition under

Section 4 of the SC(R)A, 1956 to start trading derivatives. The

derivatives exchange/segment should have a separate governing council

and representation of trading/clearing members shall be limited to

maximum of 40% of the total members of the governing council. The

exchange would have to regulate the sales practices of its members and

would have to obtain prior approval of SEBI before start of trading in

any derivative contract.

The Exchange should have minimum 50 members.

The members of an existing segment of the exchange would not

automatically become the members of derivative segment. The members

of the derivative segment would need to fulfill the eligibility conditions

as laid down by the L. C. Gupta committee.

The clearing and settlement of derivatives trades would be through a

SEBI approved clearing corporation/house. Clearing

corporations/houses complying with the eligibility conditions as laid

down by the committee have to apply to SEBI for grant of approval.

59

Derivative brokers/dealers and clearing members are required to seek

registration from SEBI. This is in addition to their registration as brokers

of existing stock exchanges. The minimum networth for clearing

members of the derivatives clearing corporation/house shall be Rs.300

Lakh. The networth of the member shall be computed as follows:

Capital + Free reserves

Less non-allowable assets viz.,

Fixed assets

Pledged securities

Member’s card

Non-allowable securities(unlisted securities)

Bad deliveries

Doubtful debts and advances

Prepaid expenses

Intangible assets

30% marketable securities

The minimum contract value shall not be less than Rs.2 Lakh.

Exchanges have to submit details of the futures contract they propose to

introduce.

The initial margin requirement, exposure limits linked to capital

adequacy and margin demands related to the risk of loss on the

position will be prescribed by SEBI/Exchange from time to time.

60

The L. C. Gupta committee report requires strict enforcement of “Know

your customer” rule and requires that every client shall be registered

with the derivatives broker. The members of the derivatives segment are

also required to make their clients aware of the risks involved in

derivatives trading by issuing to the client the Risk Disclosure

Document and obtain a copy of the same duly signed by the client.

The trading members are required to have qualified approved user and

sales person who have passed a certification programme approved by

SEBI. The derivatives exchange/segment should have a separate

governing council and representation of trading/clearing members shall

be limited to maximum of 40% of the total members of the governing

council. The exchange would have to regulate the sales practices of its

members and would have to obtain prior approval of SEBI before start

of trading in any derivative contract.

Analysis and Interpretation

61

Q.1 Are you trading in derivative market?

Frequencies Percentage

Yes 74 37.0

No 126 63.0

Total 200 100.0

Objective: To know that whether the investors are trading in derivative

market or not.

Q.2 Reasons for not investing in derivative market.

Objective : To know the reason why investors are not trading in

trading in derivative market.

Reasons Frequency Percent

Lack of knowledge 26 20.6

Lack of awareness 19 15.1

High risky 62 49.2

Huge amount of

investment

17 13.5

Other 2 1.6

Total 126 100

Q.3 what is the objective of trading in derivative market?

Objective: To know that why they are trading in derivative market.

Frequency Percent

Don’t trade 126 63.0

62

Not at all preferred 2 1.0

Neutral 2 1.0

Some how preferred 5 2.5

Most preferred 65 32.5

Total 200 100

Q.4 What are the criteria do you taken in the consideration while investing

in derivative market?

Objective : To know that which criteria are consider by the investors while

they are investing in derivative market. Which criteria are most important

for them whether derivatives are ease in transaction, less costly, or

available of different contract or for the margin money.

Frequency Percent

Don’t trade 126 63.0

Not at all preferred 2 1.0

Some how not

preferred

4 2.0

Neutral 16 8.0

Some how preferred 23 11.5

Most preferred 29 14.5

Total 200 100

Q-5 Give your preference of trading in derivative instrument.

Objective: To know the preference of the investors while they are

63

trading in derivative market.

Frequency Percent

Don’t trade 126 63.0

Not at all preferred 1 .5

Some how not

preferred

1 .5

Neutral 15 7.5

Some how preferred 14 7.0

Most preferred 43 21.5

Total 200 100

Q-6 Give your preference in term of trading in derivative

market?

Objective : To know the preference of the investors in term of

trading in derivative market.

Frequency Percent

Don’t trade 126 63.0

Not at all preferred 4 2.0

Some how not

preferred

1 .5

Neutral 5 2.5

Some how preferred 10 5

Most preferred 54 27

Total 200 100

Q-7 How much percentage of your income you trade in derivative market?

64

Objective: To know investors are how much percentage of their

income trade in derivative market.

Frequency Percent

Don’t trade 126 63.0

Less than 5% 8 4.0

5%-10% 25 12.5

11%-15% 25 12.5

16%-20% 13 6.5

More than 20% 3 1.5

Total 200 100

Q-8 what is the rate of return expected by you from derivative market?

Objective: To know the investors expectation towards their

investment in derivative market.

Frequency Percent

Do not trade 126 63.0

5%-9% 21 10.5

10%-13. % 22 11.0

14%-17. % 23 11.5

18%-23% 8 4.0

Total 200 100

Q-9. You are satisfied with the current performance of the derivative

market.

65

Objective: To know that investors are satisfied with the performance of the

derivative market or not.

Frequency Percent

Do not trade 126 63.0

Strongly disagree 8 4.0

Disagree 14 7.0

Neutral 18 9.0

Agree 25 12.5

strongly agree 9 4.5

Total 200 100

Gender:

Frequency Percent

Male 157 78.5

Female 43 21.5

Total 200 100

Age:

Frequency Percent

Below 20 years 3 1.5

20-25 years 61 30.5

26-30 years 51 25.5

31-35 years 43 21.5

above 35 years 42 21.0

66

Total 200 100

Occupation:

Frequency Percent

Student 35 17.5

Employeed 82 41.0

Business 32 16.0

Professional 22 11.0

Housewife 13 6.5

Others 16 8.0

total 200 100

Findings and Suggestions

67

Here we found that out of 200 investors 74 means 37% investors are

trading in derivative market whereas 126 means 63% are not trading

in derivative market.

Reasons for not investing in derivative market Is derivative is because

lack of awareness and knowledge, high risky, need huge amount of

investment.

The main objective I of trading in derivative market of the investors is

getting high return.

Criteria for trading is considered by investors are derivatives in

derivative they get margin money and derivatives are more liquid.

Their attractive preference is index future and index options

Most of the investors are trading intraday.

Out of 200 investors 12.5% investors are investing 11% to 15% of

their income trading in derivative market.

12.5% are satisfied with derivative market.

157male investors and 43 female investors out of 200 investors.

Most of the businessman and employed are trading in derivative

market.

Recommendations

68

Only 74 investors are trading whereas 126 are not trading .so attract

them for trading.

19 are lack of awareness so make them aware with the derivative so

increase the customer.

Out of 126, 26 don’t have knowledge for derivative so provide

them knowledge for trading in derivative market.

Those who are not satisfied with the derivative by knowing their

behavior of investment make them satisfied. Because negative word

mouth of the customers fall down the business. And good word of

mouth builds the business.

Conclusion

69

The awareness regarding Derivative among investor is 78 percent

In terms of investment in Derivative and Equity investors have

Capability of taking risk.

Investors also prefer Safety and Time Factor as the important

parameter for investing.

The important factor that affecting the investor decision is based on

In Consult With Their Broke .

Bibliography

70

Websites referred –:

http://www.nseindia.com, (last accessed on 3 Aug ,2010, 2:00 pm)

http://www.bseindia.com, (last accessed on 3 Aug ,2010, 4:30 pm)

http://www.msbetrade.com, (last accessed on 6 Aug, 2010, 6:00 pm)

http://www.mcx.com. , (last accessed on 6 Aug , 2010 , 7:30 pm)

http://www.ncdex.com , (last accessed on 8 Aug , 2010 , 5:00 pm)

http://www.moneycontrol.com , (last accessed on 9 Aug , 2:30 pm)

Books-:

Satyajit Das ( 3rd edition revised) , Derivative Products and Pricing,

Wiley Finance

Satyajit Das (Revised Edition) , Traders Guns & Money , Whiley

Finance

AnnexureQuestionnaire

Q1. Are you investing in Derivative Market?

71

Yes

No

Q2. Reason for not investing in Derivative Market.

{Give the rank}

Lack of Knowledge

Lack of awareness

High risky

Huge amount of investment

other

Q3.What are the objectives of the investing in derivatives Market ?

Scale 5 4 3 2 1

Instrument Most

prefered

Somewhat

prefered

Neutral Somewhat

not

prefered

Not at

all

Prefered

High

Return

Hedge

The Risk

More

reliable

Safe to

invest in

derivative

market

72

More

Liquid

Q4. What are the criteria do you taken in the consideration while investing

in derivative market?

Scale 5 4 3 2 1

Instrument Most

prefered

Somewhat

prefered

Neutral Somewhat

not

prefered

Not at

all

prefered

Flexibilty

Ease in

transaction

Less costly

Availabilty

ogf

different

Contract

Margin

money

Q5. Give your preference of investment in derivative instrument.

Scale 5 4 3 2 1

73

Instrument Most

prefered

Somewhat

prefered

Neutral Somewhat

not

prefered

Not all

Prefered

Index

future

Stock

Future

Index

Option

Stock

Option

Q6. Give your preference in terms of investment in derivative market.

Scale 5 4 3 2 1

Instrument Most

prefered

Somewhat

prefered

Neutral Somewhat

not

prefered

Not all

Prefered

Short term

Medium

term

Long term

Q7. How much Percentage of your income you invest in derivative

market?

74

Less than 5%

5% TO 10%

11% TO 15%

16% TO 20%

More Than 20%

Q8. What is the rate of return expected by you from derivative market ?

5 % TO 9.5%

10% TO 13.5%

14 % TO 17%

18% TO 23%

Above 23%

Q9. You are satisfied with the current performance of the derivative in

terms of expected return.

Strongly Agree

Agree

Neutral Disagree

Strongly Disagree

Demographic profile

Name:………………………

Contact No............................

Email id:……………………

Age-:

Below 20 yrs.

20 – 30 yrs.

75

30-40 yrs.

40-50 yrs

Above 50 yrs.

Gender-:

Male

Female

Income (yearly)-:

Less than 100000

100000-200000

200000-300000

300000-400000

Above 400000

76