Derivatives In India

Capstone Project by :- Manav Sabharwal 201350076

Basic Derivatives

• Options• Futures• Forwards

Participants In Derivatives Markets

• Hedgers• Speculators, and• Arbitrageurs

Tables Explaining F&O Markets

• Positive trend: It gives information about the top gainers in the futures market.• Negative trend: It gives information about the top losers in the futures

market.• Future OI gainers: It lists those futures whose % increases in open

interest are among the highest on that day.• Future OI losers: It lists those futures whose % decreases in open

interest are among the highest on that day.• Active Calls: Calls with high trading volumes on that particular day.• Active Puts: Puts with high trading volumes on that particular day.

Taxation of Derivative Instruments• . The only tax provisions which had indirect bearing on derivatives

transactions were sections 73(1) and 43(5). Under these sections, trade in derivatives was considered “speculative transactions” for the purpose of determining tax liability. All profits and losses were taxed under the speculative income category. Therefore, loss on derivatives transactions could be set off only against other speculative income and the same could not be set off against any other income. This resulted in high tax liability.

• Finance Act, 2005 has amended section 43(5) so as to exclude transactions in derivatives carried out in a “recognized stock exchange” from ‘speculative transaction’. This implies that derivatives transactions that take place in a “recognized stock exchange” are not taxed as speculative income or loss. They are treated under the business income head of the Income tax Act. Any losses on these activities can be set off against any business income in the year and the losses can be carried forward and set off against any other business income for the next eight years.

Risk Measurement Techniques By NSE• The objective of SPAN is to identify overall risk in a portfolio of futures and options contracts for each

member. The system treats futures and options contracts uniformly, while at the same time recognizing the unique exposures associated with options portfolios like extremely deep out-of-the-money short positions, inter-month risk and inter-commodity risk.

• Because SPAN is used to determine performance bond requirements (margin requirements), its overriding objective is to determine the largest loss that a portfolio might reasonably be expected to suffer from one day to the next day.

• In standard pricing models, three factors most directly affect the value of an option at a given point in time:• Underlying market price• Volatility (variability) of underlying instrument• Time to expiration• As these factors change, so too will the value of futures and options maintained within a portfolio. SPAN

constructs scenarios of probable changes in underlying prices and volatilities in order to identify the largest loss a portfolio might suffer from one day to the next. It then sets the margin requirement at a level sufficient to cover this one-day loss.

Risk Mechanics By SPAN

• The complex calculations (e.g. the pricing of options) in SPAN are executed by the Clearing Corporation. The results of these calculations are called Risk arrays. Risk arrays, and other necessary data inputs for margin calculation are then provided to members on a daily basis in a file called the SPAN Risk Parameter file.• Members can apply the data contained in the Risk parameter files to their specific

portfolios of futures and options contracts to determine their SPAN margin requirements.• Hence members need not execute complex option pricing calculations which are

performed by NSCCL. SPAN has the ability to estimate risk for combined futures and options portfolios and re-value the same under various scenarios of changing market conditions.

Conclusion

• The trades in options and futures are more complex then it seems and people lose their money easily on these trades so there is need of more insight knowledge on these instruments and trading methodologies should be applied.• There is more financial illiteracy in the traders who trade in

derivatives which leads to more losses and also there is no knowledge among them so as to the tax which they have to pay on the same.