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This is a project on option strategis
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1.1 INTRODUCTION
A derivative is a security whose value depends on the value of more basic
underlying variable. These are also known as contingent claims. Derivative
securities have been very successful innovation in capital market.
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. The past decade has
witnessed a massive growth in the use of financial derivatives by a wide range
of corporate and financial institutions. This growth has run in parallel with the
increasing direct reliance of companies on the capital market as the major
source of long term funding. In this respect, derivatives have a vital role to play
in enhancing shareholder value by ensuring minimum risk of investment.
During this project I will get to know different ways or different strategies by
using which, investor can minimizes the loss. An individual always faces the
problem as to which strategy he should use in different market condition. During
this course of Internship I am going together a good knowledge of cash and
derivative market. This knowledge was helpful in my project to achieve the
objective.
I am going to work out on strategies, by applying which, in
appropriate market condition an investor can minimize his risk/loss and even
earn profit by only taking positions.
1
1.2 NEED OF THE STUDY In the recent times the derivative markets have gained importance in term of
their vital role in the economy. The increasing investment in derivatives
(Domestic as well as overseas) have attracted my interest in this area. Though
the use of derivative products, it is possible to partially or fully transfer price risk
by locking in asset prices. As the volume of trading is tremendously increasing in
derivative market, this analysis will be of immense help to the investors.
The study has been done to know the different types of derivatives and also to
know the derivative market in India. This study also covers how to minimize risk
through derivatives with the help of options in equity segment, as a financial
advisor able to understand risk minimization with examples. Through this study I
came to know the trading done in derivatives and their use in special situations.
1.3 SCOPE OF THE STUDY The study is limited to “Derivatives with special references to
futures and options in the Indian context & the NIFTY ’50 companies from the
Net worth stock broking has been taken as a representative sample for the
study.
The study can’t be said as totally perfect. Any alteration may
occur. The study has only made humble attempt at evaluating derivatives only in
India markets. The study is not based on the international perspective of
derivative markets.
The project covers the derivatives market and its instruments.
For better understanding various strategies with different situations and actions
have been given. It includes the data collected in the recent years and also the
market in the derivatives in the recent years. This study extends to the trading of
derivatives done in the National Stock Exchange.
2
1.4OBJECTIVES OF STUDY
To understand online trading process in NETWORTH STOCK BROKING LTD.
To analyze the process of future and option and Comparison of
profits/loses in cash market and derivative market.
To find out profit/losses position of the option writer and option holder
the purpose to analyze the factors that affect the company’s performance
To understand how to minimize or hedge the risk by using strategies of
Derivatives.
1.5 METHODOLOGY AND DATABASE A common training program was going to attend at NETWORTH STOCK
BROKING Limited, Dilsukhnagar, Hyderabad. For general awareness of capital
markets in India. The instructors of training program will provide advisory
support regarding the procedure of performing the project work and with certain
references for data collection.
3
The investors use these methods and then analyze the share price
and they invest in the various companies.
Source of study All the data for the analysis have been collected from respective
company websites and other websites. The fundamental data collected was
regarding the Indian economy, Industrial level performance, individual company
balance sheet, income statements, annual reports and shareholding patterns.
The theoretical data will be gathered from text books, websites and newspapers.
Share price quotations will be collected from newspapers.
The following steps are involved in the studySelection of scripSelection of scrip is done on a random basis and the scrip selected is NIFTY
’50. The lot is of 50 sizes, profitability position of futures, buyers and sellers &
also the option holders and option writers is studied.
Data CollectionData collection is from, the data which has already been collected by someone
or an organization for some other purpose or research study .The data for study
has been collected from various sources such as :Books, Journals, News pares
& electronic media Internet sources
AnalysisThe analysis consist of the tabulation of the data assessing the profitability
position of the future buyers & sellers and also the option holder & the option
writer representing the data with graphs and making interpretation using data.
And apply some strategies how to minimize the risk with live examples.
2.1 LITERATURE REVIEWDerivatives is a product whose value is derived from the one or more basic
Variables, called base (underlying asset, index, or value of reference rate), in a
Contractual manner. The underlying asset can be equity, forex, commodity or
any other asset.
4
The Indian context the securities contrasts (regulation) act, 1956 (SCR Act)
defines “derivative” as
1) A security derived from an instrument, share, loan whether secured or
unsecured, risk instrument or contract for differences or any other
form of security.
2) A contract, which derives its value from the prices, or index of prices,
or Underlying securities.
Futures contracts, forward contracts, options and swaps are the most common
types of derivatives. Because derivatives are just contracts, just about based on
weather data, such as the amount of rain or the number of anything can be used
as an underlying asset. There are even derivatives sunny days in a particular
region. Derivatives are generally used to hedge risk, but can also be used
for speculative purposes
Evaluation of Derivatives Derivatives can be found throughout the history of mankind. In the
Middle Ages, engaging in contracts at predetermined prices for future delivery of
farming products. The new era for the derivative markets was ushered with the
introduction of financial derivatives, and it continues to last to this day. Although
commodity derivatives are still quite active, particularly oil and precious metals,
financial derivatives dominate trading in the current derivative markets. Although
the derivatives markets slowed down considerably by the end of the 20th
century, that did not mean that there were not a steady offering of existing, as
well as new derivative products. Derivatives exchanges also went through a
period of change; some consolidated, some merged, some became for-profit
institutions. Regardless, they all had something in common—the need for less
regulation.
Aside from structural changes, some derivative exchanges also
changed the way they conducted trading. Old systems of face-to-face trading on
trading floors have been replaced with electronic trading, and telephone and
5
computer networks. With the advent of Internet, electronic trading evolved into
e-trading. And although trading floors still dominate derivative markets in the
U.S., it is obvious that to stay competitive, the U.S. will have to eventually
embrace electronic trading.
The following factors have contributed to the growth of financial derivatives
1) Increased volatility in asset prices in financial markets.
2) Increased integration of national financial markets with the international
markets.
3) Marked improvement in communication facilities and sharp decline in
their costs.
4) Development of more sophisticated risk management tools, providing
economic agents a wider choice of risk management strategies
5) Innovations in the derivatives markets, which optimally combine the risks
and returns over a large number of financial assets leading to higher
returns, reduced risk as well as transactions costs as compared to
individual financial assets.
6) Technology facilitates the ability to track the payoffs and risk exposures
associated with a portfolio of derivative positions.
7) An important factor in the growth of derivatives market has been a variety
of intellectual advances. The development of economic models for
valuing derivative instruments and assessing their riskiness and the
increasing sophistication of such models has played a crucial role in the
growth of the market.
ARTICLES
6
REVIEW-1Author: Naratcharupat
Title: The effect of derivative trading on the underlying markets: Evidence from
Canadian installment receipts trading
Source: DeGroote School of Business, McMaster University.
Abstract:We examine the impact of installment receipts (IR’s) trading on the underlying
stock’s volatility IR’s is a derivative security that evidences the purchase of an
underlying security on an installment basis. IR’s has been commonly used to
facilitate large secondary stock offering in Canada and other common wealth
countries. We find that while the trading of IR’s generally increases the
underlying stock trading volume, it generally does not have a significant effect
on the underlying volatility or systematic risk. Therefore, the use of IR’s in
secondary offering will not destabilize the underlying markets and thus will not
adversely affect the welfare of the buyers and the remaining shareholders.
REVIEW-2Author: Bombay stock exchange
Title: BSE to start physical settlement for stock F&O
7
Source: News paper (Times of India)
Abstract:Asia’s oldest bourse, the Bombay Stock Exchange (BSE) declared that it will be
introducing physical settlement for all single stock derivatives contracts expiring
on or after 13 April.
All futures and options contracts traded on the two national bourses - BSE and
National Stock Exchange (NSE) have been cash settled ever since derivatives
were introduced in India in 2000. Cash based settlement in the derivatives
segment allows an investor to take a bet on a stock or index without taking a
position in the cash market. On 15 July, capital market regulator Securities and
Exchanges Board of India (SEBI) had issued circular allowing exchanges the
flexibility to introduce either cash or physical settlement on stock futures and
options.
REVIEW-3
Author: Louis H.Ederigton.
Title: Financial derivatives markets in India.
Source: The Indian journal of finance.
Abstract:
8
The financial sector reforms in the decade of 1990’s have transformed the
Indian capital market
In to a modern wonder is vibrant and global. The year 2001 was special for the
Indian capital market as the derivative segments was introduced. A derivative is
a financial instrument, which derives its value from some other financial price.
The most commonly used derivatives contracts are forwards, futures, options
and swaps, with the introduction of derivatives, the speculative trades have a
shifted to a more controlled environment with risk containment measures like
margining, monitoring and surveillance of the activities of various participants
derivatives trading, commenced in India in June 2000 after the SEBI granted the
approval to this effect in may 2001.
REVIEW-4
Author: Golaka C Nath.
Title: Behavior of stock market volatility after derivatives.
Source: Research paper (NSE).
Abstract:Financial market liberalization since 1990’s has brought about major changes in
the financial market in India. The creation and empowerment of (SEBI) has
9
helped in providing higher level accountability in the market. New institutions like
(NSE), NSCCL, NSDL, have been change agents and helped cleaning the
system and provided safety to investing public at large. Introduction of
derivatives in Indian capital market was initiated by the government through
L.C.Gupta committee report. The L.C.Gupta committee on derivatives had
recommended in December 1997 the introduction of stock index futures is the
first place to be followed by other products once the market matures.
REVIEW-5
Author: Metzyer, Lawrence.
Title: Introducing derivative accounting.
Source: The journal of government financial management.
Abstract:In June, the government accounting standards board (GASB) issued a
statement 53 accounting and financial reporting for derivative instruments which
details the accounting and financial reporting for derivatives instruments. This
articles is based largely on the requirements of the standards and is intended to
introduce readers, through the use of an interest rate swap example, to the
10
accept of derivatives and the basic implementation guidelines set forth in the
news standard.
REVIEW-6
Author: SEBI, based on there commendations of the Derivatives Market Review
Committee and in consultation with stock exchanges.
Title: Physical settlement of stock derivatives
Source: Research paper (SEBI)
Abstract:In continuation to SEBI’s circular dated June 20, 2001 and November 02, 2001
regarding settlement of stock options and stock futures contracts respectively,
SEBI, based on the recommendations of the Derivatives Market Review
Committee and in consultation with stock exchanges, has decided to provide
flexibility to stock exchanges to offer:
a) Cash settlement (settlement by payment of differences) for both stock options
and stock futures; or
11
b) Physical settlement (settlement by delivery of underlying stock) for both stock
options and stock futures; or
c) Cash settlement for stock options and physical settlement for stock futures; or
d) Physical settlement for stock options and cash settlement for stock futures.
Vide its circular dated July 15, 2010 SEBI has decided that stock exchanges
may introduce physical settlement in a phased manner. On introduction,
however, physical settlement for all stock options and/or all stock futures must
be completed within six months of its introduction.
INDIA INFOLINE LIMITED
India Infoline is a one-stop financial services shop, most respected for quality of its information, personalized service and cutting-edge technology.
Vision:
Our vision is to be the most respected company in the financial services space.
India Infoline Group:
The India Infoline group, comprising the holding company, India Infoline Limited and its wholly-owned subsidiaries, include the entire financial services space with offerings ranging from Equity research, Equities and derivatives trading, Commodities trading, Portfolio Management Services, Mutual Funds, Life Insurance, Fixed deposits, GoI bonds and other small savings instruments to loan products and Investment banking. India Infoline also owns and manages the websites www.indiainfoline.com and www.5paisa.com. The company has a network of over 2100 business locations (branches and sub-brokers) spread across more than 450 cities and towns. The group caters to approximately a million customers.
Founded in 1995 by Mr. Nirmal Jain (Chairman and Managing Director) as an independent business research and information provider, the company gradually evolved into a one-stop financial services solutions provider.
India Infoline received registration for a housing finance company from the National Housing Bank and received the ‘Fastest growing Equity Broking House - Large firms’ in India by Dun & Bradstreet in 2009. It also received the Insurance broking license from IRDA; received the venture capital license; received in principle approval to sponsor a
12
mutual fund; received ‘Best broker- India’ award from Finance Asia; ‘Most Improved Brokerage- India’ award from Asia money.
COMPANY STRUCTURE:
India Infoline Limited is listed on both the leading stock exchanges in India, viz. the Stock Exchange, Mumbai (BSE) and the National Stock Exchange (NSE) and is also a member of both the exchanges. It is engaged in the businesses of Equities broking, Wealth Advisory Services and Portfolio Management Services. It offers broking services in the Cash and Derivatives segments of the NSE as well as the Cash segment of the BSE. It is registered with NSDL as well as CDSL as a depository participant, providing a one-stop solution for clients trading in the equities market. It has recently launched its Investment banking and Institutional Broking business. A SEBI authorized Portfolio Manager; it offers Portfolio Management Services to clients. These services are offered to clients as different schemes, which are based on differing investment strategies made to reflect the varied risk-return preferences of clients.
OBJECTIVES OF STUDY
To understand online trading process in IIFL To analyze the process of future and option and Comparison of the profits/losses
in cash market and derivative market. To find out profit/losses position of the option writer and option holder with the
purpose to analyze the factors that affect the company’s Performance. To understand how to minimize or hedge the risk by using strategies of
Derivatives.
METHODOLOGY
A common training program was going to attend at IIFL, Secretariat, Hyderabad. For general awareness of capital markets in India. The instructors of training program will provide advisory support regarding the procedure of performing the project work and with certain references for data collection. The investors use these methods and then analyze the share price and they invest in the various companies.
Source of study
All the data for the analysis have been collected from respective company websites and other websites. The fundamental data collected was regarding the Indian economy, Industrial level performance, individual company balance sheet, income statements, annual reports and shareholding patterns. The theoretical data will be gathered from text books, websites and newspapers. Share price quotations will be collected from newspapers.
13
The following steps are involved in the study
Selection of scrip
Selection of scrip is done on a random basis and the scrip selected is NIFTY ’50. The lot is of 50 sizes, profitability position of futures, buyers and sellers & also the option holders and option writers will be studied.
Data Collection
Data collection is from, the data which will be collecting by someone or an organization for some other purpose or research study .The data for study will be collecting from various sources such as :Books, Journals, News pares & electronic media Internet sources
Analysis
The analysis consist of the tabulation of the data assessing the profitability position of the future buyers & sellers and also the option holder & the option writer representing the data with graphs and making interpretation using data. And apply some strategies how to minimize the risk with live examples.
LITERATURE REVIEW
Derivatives is a product whose value is derived from the one or more basic Variables, called base (underlying asset, index, or value of reference rate), in a Contractual manner. The underlying asset can be equity, forex, commodity or any other asset. The Indian context the securities contrasts (regulation) act, 1956 (SCR Act) defines “derivative” as
3) A security derived from an instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security.
4) A contract, which derives its value from the prices, or index of prices, or Underlying securities.
Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Because derivatives are just contracts, just about based on weather data, such as the amount of rain or the number of anything can be used as an underlying asset. There are even derivatives sunny days in a particular region. Derivatives are generally used to hedge risk, but can also be used for speculative purposes
Evaluation of Derivatives
14
Derivatives can be found throughout the history of mankind. In the Middle Ages, engaging in contracts at predetermined prices for future delivery of farming products. The new era for the derivative markets was ushered with the introduction of financial derivatives, and it continues to last to this day. Although commodity derivatives are still quite active, particularly oil and precious metals, financial derivatives dominate trading in the current derivative markets. Although the derivatives markets slowed down considerably by the end of the 20th century, that did not mean that there were not a steady offering of existing, as well as new derivative products. Derivatives exchanges also went through a period of change; some consolidated, some merged, some became for-profit institutions. Regardless, they all had something in common—the need for less regulation.
Aside from structural changes, some derivative exchanges also changed the way they conducted trading. Old systems of face-to-face trading on trading floors have been replaced with electronic trading, and telephone and computer networks. With the advent of Internet, electronic trading evolved into e-trading. And although trading floors still dominate derivative markets in the U.S., it is obvious that to stay competitive, the U.S. will have to eventually embrace electronic trading.
The following factors have contributed to the growth of financial derivatives8) Increased volatility in asset prices in financial markets.9) Increased integration of national financial markets with the international
markets.10)Marked improvement in communication facilities and sharp decline in their
costs.11)Development of more sophisticated risk management tools, providing economic
agents a wider choice of risk management strategies12) Innovations in the derivatives markets, which optimally combine the risks and
returns over a large number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets.
13)Technology facilitates the ability to track the payoffs and risk exposures associated with a portfolio of derivative positions.
14)An important factor in the growth of derivatives market has been a variety of intellectual advances. The development of economic models for valuing derivative instruments and assessing their riskiness and the increasing sophistication of such models has played a crucial role in the growth of the market.
REVIEW-1Author: Naratcharupat
Title: The effect of derivative trading on the underlying markets: Evidence from Canadian installment receipts trading
Source: DeGroote School of Business, McMaster University.
15
Abstract:
We examine the impact of installment receipts (IR’s) trading on the underlying stock’s volatility IR’s is a derivative security that evidences the purchase of an underlying security on an installment basis. IR’s has been commonly used to facilitate large secondary stock offering in Canada and other common wealth countries. We find that while the trading of IR’s generally increases the underlying stock trading volume, it generally does not have a significant effect on the underlying volatility or systematic risk. Therefore, the use of IR’s in secondary offering will not destabilize the underlying markets and thus will not adversely affect the welfare of the buyers and the remaining shareholders.
INDUSTRY PROFILE
Stock market
A stock market (equity market) is a private or public market for the trading of company stock and derivatives of company stock at an agreed price; both of these are securities listed on a stock exchange as well as those only traded privately. The expression 'stock market' refers to the market that enables the trading of company stocks (collective shares), other securities, and derivatives. Bonds are still traditionally traded in an informal, over-the-counter market known as the bond market. Commodities are traded in commodities markets, and derivatives are traded in a variety of markets (but, like bonds, mostly 'over-the-counter'). The stocks are listed and traded on stock exchanges which are entities (a corporation or mutual organization) specialized in the business of bringing buyers and sellers of stocks and securities together. The stock market in the United States includes the trading of all securities listed on the NYSE, the NASDAQ
3.2 INDUSTRY PROFILE
Stock market A stock market (equity market) is a private or public market for
the trading of company stock and derivatives of company stock at an agreed
16
price; both of these are securities listed on a stock exchange as well as those
only traded privately.
The expression 'stock market' refers to the market that enables
the trading of company stocks (collective shares), other securities, and
derivatives. Bonds are still traditionally traded in an informal, over-the-counter
market known as the bond market. Commodities are traded in commodities
markets, and derivatives are traded in a variety of markets (but, like bonds,
mostly 'over-the-counter').
The stocks are listed and traded on stock exchanges which are
entities (a corporation or mutual organization) specialized in the business of
bringing buyers and sellers of stocks and securities together. The stock market
in the United States includes the trading of all securities listed on the NYSE, the
NASDAQ .
Trading Participants in the stock market range from small individual stock
investors to large hedge fund traders, who can be based anywhere. Their orders
usually end up with a professional at a stock exchange, who executes the order.
Some exchanges are physical locations where transactions are
carried out on a trading floor, by a method known as open outcry. This type of
auction is used in stock exchanges and commodity exchanges where traders
may enter "verbal" bids and offers simultaneously. The other type of exchange is
a virtual kind, composed of a network of computers where trades are made
electronically via traders.
Actual trades are based on an auction market paradigm where a
potential buyer bids the specific price for a stock and a potential seller asks a
specific price for the stock. (Buying or selling at market means you will accept
17
any ask price or bid price for the stock, respectively.) When the bid and ask
prices match, a sale takes place on a first come first served basis if there are
multiple bidders or askers at a given price.
The purpose of a stock exchange is to facilitate the exchange of
securities between buyers and sellers, thus providing a marketplace (virtual or
real). The exchanges provide real-time trading information on the listed
securities, facilitating price discovery.
The New York Stock Exchange is a physical exchange, also
referred to as a listed exchange — only stocks listed with the exchange may be
traded.
The NASDAQ is a virtual listed exchange, where all of the trading
is done over a computer network. The process is similar to the New York Stock
Exchange. However, buyers and sellers are electronically matched. One or
more NASDAQ market makers will always provide a bid and ask price at which
they will always purchase or sell 'their' stock.
Market participants Many years ago, worldwide, buyers and sellers were individual
investors, such as wealthy businessmen, with long family histories (and
emotional ties) to particular corporations. Over time, markets have become more
"institutionalized"; buyers and sellers are largely institutions (e.g., pension funds,
insurance companies, mutual funds, hedge funds, investor groups, and banks).
The rise of the institutional investor has brought with it some improvements in
market operations. Thus, the government was responsible for "fixed" (and
exorbitant) fees being markedly reduced for the 'small' investor, but only after
the large institutions had managed to break the brokers' solid front on fees (they
then went to 'negotiated' fees, but only for large institutions).
18
Importance of stock marketFunction and purpose The stock market is one of the most important sources for
companies to raise money. This allows businesses to go public, or raise
additional capital for expansion. The liquidity that an exchange provides affords
investors the ability to quickly and easily sell securities. This is an attractive
feature of investing in stocks, compared to other less liquid investments such as
real estate.
History has shown that the price of shares and other assets is an
important part of the dynamics of economic activity, and can influence or be an
indicator of social mood. Rising share prices, for instance, tend to be associated
with increased business investment and vice versa. Share prices also affect the
wealth of households and their consumption. Therefore, central banks tend to
keep an eye on the control and behavior of the stock market and, in general, on
the smooth operation of financial system functions. Financial stability is the
raison d'être of central banks.
Exchanges also act as the clearinghouse for each transaction,
meaning that they collect and deliver the shares, and guarantee payment to the
seller of a security. This eliminates the risk to an individual buyer or seller that
the counterparty could default on the transaction.
The smooth functioning of all these activities facilitates economic
growth in that lower costs and enterprise risks promote the production of goods
and services as well as employment. In this way the financial system contributes
to increased prosperity.
19
Relation of the stock market to the modern financial systemThe financial system in most western countries has undergone a remarkable
transformation. One feature of this development is disintermediation. A portion
of the funds involved in saving and financing flows directly to the financial
markets instead of being routed via banks' traditional lending and deposit
operations. The general public's heightened interest in investing in the stock
market, either directly or through mutual funds, has been an important
component of this process. Statistics show that in recent decades shares have
made up an increasingly large proportion of households' financial assets in
many countries.
In the 1970s, in Sweden, deposit accounts and other very liquid
assets with little risk made up almost 60 per cent of households' financial wealth,
compared to less than 20 per cent in the 2000s. The major part of this
adjustment in financial portfolios has gone directly to shares but a good deal
now takes the form of various kinds of institutional investment for groups of
individuals, e.g., pension funds, mutual funds, hedge funds, insurance
investment of premiums, etc. The trend towards forms of saving with a higher
risk has been accentuated by new rules for most funds and insurance,
permitting a higher proportion of shares to bonds.
The stock market, individual investors, and financial risk Riskier long-term saving requires that an individual possess the
ability to manage the associated increased risks. Stock prices fluctuate widely,
in marked contrast to the stability of (government insured) bank deposits or
bonds. This is something that could affect not only the individual investor or
household, but also the economy on a large scale. The following deals with
some of the risks of the financial sector in general and the stock market in
particular. This is certainly more important now that so many newcomers have
entered the stock market, or have acquired other 'risky' investments (such as
'investment' property, i.e., real estate and collectables).
20
This is a quote from the preface to a published biography about
the long-term value-oriented investor Warren. Buffett began his career with
$100, and $105,000 from seven limited partners consisting of Buffett's family
and friends. Over the years he has built himself a multi-billion-dollar fortune. The
quote illustrates some of what has been happening in the stock market during
the end of the 20th century and the beginning of the 21st.
The behavior of the stock market
From experience we know that investors may temporarily pull
financial prices away from their long term trend level. Over-reactions may occur
—so that excessive optimism (euphoria) may drive prices unduly high or
excessive pessimism may drive prices unduly low. New theoretical and empirical
arguments have been put forward against the notion that financial markets are
efficient.
According to the Efficient Market Hypothesis (EMH), only
changes in fundamental factors, such as profits or dividends, ought to affect
share prices., while the EMH predicts that all price movement (in the absence of
change in fundamental information) is random (i.e., non-trending), many studies
have shown a marked tendency for the stock market to trend over time periods
of weeks or longer.
Other research has shown that Psychological Factors may result
in exaggerated stock price movements. Psychological research has
demonstrated that people are predisposed to 'seeing' patterns, and often will
perceive a pattern in what is, in fact, just noise. (Something like seeing familiar
shapes in clouds or ink blots.) In the present context this means that a
succession of good news items about a company may lead investors to
overreact positively (unjustifiably driving the price up). A period of good returns
21
also boosts the investor's self-confidence, reducing his (psychological) risk
threshold.
Another phenomenon—also from psychology—that works
against an objective assessment is group thinking. As social animals, it is not
easy to stick to an opinion that differs markedly from that of a majority of the
group. An example with which one may be familiar is the reluctance to enter a
restaurant that is empty; people generally prefer to have their opinion validated
by those of others in the group.
Market profiles
National Stock Exchange (NSE) The National Stock Exchange of India (NSE)
situated in Mumbai - is the largest and most advanced
exchange with 1016 companies listed and 726 trading
members. Capital market reforms in India and the
launch of the Securities and Exchange Board of India
(SEBI) accelerated the incorporation of the second Indian stock exchange called
the National Stock Exchange (NSE) in 1992. After a few years of operations, the
NSE has become the largest stock exchange in India. Three segments of the
NSE trading platform were established one after another. The Wholesale Debt
Market (WDM) commenced operations in June 1994 and the Capital Market
(CM) segment was opened at the end of 1994. Finally, the Futures and Options
segment began operating in 2000. Today the NSE takes the 14th position in the
top 40 futures exchanges in the world.
In 1996, the National Stock Exchange of India launched S&P CNX Nifty and
CNX Junior Indices that make up 100 most liquid stocks in India. CNX Nifty is a
diversified index of 50 stocks from 25 different economy sectors. The Indices are
owned and managed by India Index Services and Products Ltd (IISL) that has a
consulting and licensing agreement with Standard & Poor's.
22
In 1998, the National Stock Exchange of India launched its web-site and was the
first exchange in India that started trading stock on the Internet in 2000. The
NSE has also proved its leadership in the Indian financial market by gaining
many awards such as 'Best IT Usage Award' by Computer Society in India (in
1996 and 1997) and CHIP Web Award by CHIP magazine (1999).
The NSE is owned by the group of leading financial institutions such as Indian
Bank or Life Insurance Corporation of India. However, in the totally de-
mutualized Exchange, the ownership as well as the management does not have
a right to trade on the Exchange. Only qualified traders can be involved in the
securities trading. The NSE is one of the few exchanges in the world trading all
types of securities on a single platform, which is divided into three segments:
Wholesale Debt Market (WDM), Capital Market (CM), and Futures & Options
(F&O) Market. Each segment has experienced a significant growth throughout a
few years of their launch. While the WDM segment has accumulated the annual
growth of over 36% since its opening in 1994, the CM segment has increased by
even 61% during the same period. The National Stock Exchange of India has
stringent requirements and criteria for the companies listed on the Exchange.
Minimum capital requirements, project appraisal, and company's track record
are just a few of the criteria. In addition, listed companies pay variable listing
fees based on their corporate capital size. The National Stock Exchange of India
Ltd. provides its clients with a single, fully electronic trading platform that is
operated through a VSAT network. Unlike most world exchanges, the NSE uses
the satellite communication system that connects traders from 345 Indian cities.
The advanced technologies enable up to 6 million trades to be operated daily on
the NSE trading platform.
NSE Mission
NSE's mission is setting the agenda for change in the securities markets in
India. The NSE was set-up with the main objectives of:
Establishing a nation-wide trading facility for equities, debt instruments
and hybrids,
23
Ensuring equal access to investors all over the country through an
appropriate communication network,
Providing a fair, efficient and transparent securities market to investors
using electronic trading systems,
Enabling shorter settlement cycles and book entry settlements systems,
and Meeting the current international standards of securities markets.
The standards set by NSE in terms of market practices and technologies
have become industry benchmarks and are being emulated by other
market participants. NSE is more than a mere market facilitator. It's that
force which is guiding the industry towards new horizons and greater
opportunities.
NSE NiftyThe S&P CNX Nifty (nicknamed Nifty 50 or simply Nifty), is the leading index for
large companies on the National Stock Exchange of India. S&P CNX Nifty is a
well diversified 50 stock index accounting for 22 sectors of the economy. It is
used for a variety of purposes such as benchmarking fund portfolios, index
based derivatives and index funds.
Nifty was developed by the economists Ajay Shah and Susan Thomas, then at
IGIDR. Later on, it came to be owned and managed by India Index Services and
Products Ltd. (IISL), which is a joint venture between NSE and CRISIL. IISL is
India's first specialized company focused upon the index as a core product. IISL
have a consulting and licensing agreement with Standard & Poor's (S&P), who
are world leaders in index services.
CNX stands for CRISIL NSE Indices. CNX ensures common branding of indices,
to reflect the identities of both the promoters, i.e. NSE and CRISIL. Thus, 'C'
stands for CRISIL, 'N' stands for NSE and X stands for Exchange or Index. The
S&P prefix belongs to the US-based Standard & Poor's Financial Information
Services.
NSE other indices S&P CNX Nifty
CNX Nifty Junior
24
CNX 100
S&P CNX 500
CNX Midcap
S&P CNX Defty
CNX Midcap 200
Bombay Stock Exchange
The Bombay Stock Exchange Limited (formerly, The Stock
Exchange, Mumbai; popularly called The Bombay Stock Exchange, or BSE) is
the oldest stock exchange in Asia. It is located at Dalal Street, Mumbai, India.
Bombay Stock Exchange was established in 1875. There are around 5,600
Indian companies listed with the stock exchange, and has a significant trading
volume. As of October2006, the market capitalization of the BSE was about Rs.
33.4 trillion (US $ 730 billion). The BSE SENSEX (Sensitive index), also called
the BSE 30, is a widely used market index in India and Asia. As of 2005, it is
among the 5 biggest stock exchanges in the world in terms of transactions
volume.
HistoryAn informal group of 22 stockbrokers began trading under a banyan tree
opposite the Town Hall of Bombay from the mid-1850s, 1875, was formally
organized as the Bombay Stock Exchange (BSE).In January 1899, the stock
exchange moved into the Brokers’ Hall after it was inaugurated by James M
MacLean. After the First World War, the BSE was shifted to an old building near
the Town Hall. In 1956, the Government of India recognized the Bombay Stock
Exchange as the first stock exchange in the country under the Securities
Contracts (Regulation) Act.1995, when it was replaced by an electronic (e-
trading) system named BOLT, or the BSE Online Trading system. In 2005, the
status of the exchange changed from an Association of Persons (AOP) to a fully
25
fledged corporation under the BSE (Corporatization and Demutualization)
Scheme, 2005 (and its name was changed to The Bombay Stock Exchange
Limited).
BSE SensexThe BSE SENSEX (also known as the BSE 30) is a value-weighted index
composed of 30 scrip’s, with the base April 1979 = 100. The set of companies
which make up the index has been changed only a few times in the last 20
years. These companies account for around one-fifth of the market capitalization
of the BSE.
SENSEX, first compiled in 1986 was calculated on a "Market Capitalization-
Weighted" methodology of 30 component stocks representing a sample of large,
well-established and financially sound companies. The base year of SENSEX is
1978-79. The index is widely reported in both domestic and international
markets through print as well as electronic media. SENSEX is not only
scientifically designed but also based on globally accepted construction and
review methodology. From September 2003, the SENSEX is calculated on a
free-float market capitalization methodology. The "free-float Market
Capitalization-Weighted" methodology is a widely followed index construction
methodology on which majority of global equity benchmarks are based.
The growth of equity markets in India has been phenomenal in the decade gone
by. Right from early nineties the stock market witnessed heightened activity in
terms of various bull and bear runs. More recently, the bourses in India
witnessed a similar frenzy in the 'TMT' sectors. The SENSEX captured all these
happenings in the most judicial manner. One can identify the booms and bust of
the Indian equity market through SENSEX.
The values of all BSE indices are updated every 15 seconds during the market
hours and displayed through the BOLT system, BSE website and news wire
agencies.
SENSEX calculation
26
SENSEX is calculated using a "Market Capitalization-Weighted" methodology.
As per this methodology, the level of index at any point of time reflects the total
market value of 30 component stocks relative to a base period. (The market
capitalization of a company is determined by multiplying the price of its stock by
the number of shares issued by the company). An index of a set of combined
variables (such as price and number of shares) is commonly referred as a
'Composite Index' by statisticians. A single indexed number is used to represent
the results of this calculation in order to make the value easier to work with and
track over time. It is much easier to graph a chart based on indexed values than
one based on actual values.
The base period of SENSEX is 1978-79. The actual total market value of the
stocks in the Index during the base period has been set equal to an indexed
value of 100. This is often indicated by the notation 1978-79=100. The formula
used to calculate the Index is fairly straightforward. However, the calculation of
the adjustments to the Index (commonly called Index maintenance) is more
complex. The calculation of SENSEX involves dividing the total market
capitalization of 30 companies in the Index by a number called the Index Divisor.
The Divisor is the only link to the original base period value of the SENSEX. It
keeps the Index comparable over time and is the adjustment point for all Index
maintenance adjustments. During market hours, prices of the index scripts, at
which latest trades are executed, are used by the trading system to calculate
SENSEX every 15 seconds and disseminated in real time. During market hours,
prices of the index scrip’s, at which trades are executed, are automatically used
by the trading computer to calculate the SENSEX every 15 seconds and
continuously updated on all trading workstations connected to the BSE trading
computer in real time.
BSE - other IndicesApart from BSE SENSEX, which is the most popular stock index in India, BSE
uses other stock indices as well:
BSE 500
BSE PSU
27
DerivativesFutureOptionForwardSwaps BSE MIDCAP
BSE SMLCAP
BSE BANKEX
4.1 DATA ANALYSIS AND INTERPRETATION A derivative is a security whose value depends on the value of
more basic underlying variable. These are also known as contingent claims.
Derivative securities have been very successful innovation in capital market.
Types of Derivatives
The most commonly used derivatives contracts are forwards, futures and
options. Here are various derivatives contacts that have come to be used given
briefly:
Forwards
Futures
Options
Warrants
LEAPS
Swaps
Swaptions
1. Forwards: 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.
28
2. 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 exchange-traded contracts.
3. Options: Options are of two types - calls and puts
Calls option 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.
Put option 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.
4. Warrants: Options generally have lives of up to one year, the majority of
options traded on options exchanges having a maximum maturity of nine
months. Longer-dated options are called warrants and are generally
traded over-the-counter.
5. 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
6. LEAPS: The acronym LEAPS means Long-Term Equity Anticipation
Securities. These are options having a maturity of up to three years.
29
7. Swaptions: Swaptions are options to buy or sell a swap that will become
operative at the expiry of the options. Thus a swaption is an option on a
forward swap. Rather than have calls and puts, the swaptions market has
receiver swaptions and payer swaptions. A receiver swaption is an option
to receive fixed and pay floating. A payer swaption is an option to pay
fixed and receive floating.
Futures A future is a contract between two parties whereby the one party
(the buyer) agrees to buy an underlying asset from the other party to the
contract on a specific future date, and at a price determined at the close of the
contract. A future is a derivative that is used to transfer the price risk of the
underlying instrument from one party to another.
The underlying asset can be a financial asset such as a bond, a currency such
as US dollars, a commodity, etc.
A future is normally classified according to the underlying
instrument. Where, for instance, two parties agree to buy and sell a specific
quantity of rice (of a certain quality) at a certain price on a future date, the
contract will be a commodity futures contract. Where two parties agree to
buy and sell bonds, this will be known as a financial futures contract, and
where two parties agree to buy and sell a certain amount of foreign currency,
this is a currency futures contract.Features of Futures
Futures are highly standardized.
The contracting parties need not pay any down payments.
Hedging of price risks.
They have secondary markets to.
A futures contract is thus an agreement between two parties
to buy and sell
a standardized type and quantity
30
of a specified underlying asset
with a certain quality
at a price determined at the closing of the contract
on a specified date
Through a central exchange.
Types of Futures On the basis of the underlying asset they derive, the futures are
divided in to two types:
1) Stock futures: The stock futures are the futures that have the underlying
asset as the individual securities. The settlement of the stock futures is of
cash settlement and the settlement price of the future is the closing price
of the underlying security. 2) Index futures: Index futures are the futures, which have the underlying asset
as an index. The index futures are also cash settled. The settlement price
of the index futures shall be the closing value of the underlying index on
the expiry date of the contract.
Parties in Futures Contract There are two parties in a future contract, the buyer and seller. The
buyer of the futures contract is one who LONG on the futures contract and the
seller of the futures contract is who is SHORT on the futures contract.
In a futures contract, both parties have an obligation,
one to buy the underlying instrument
The other to sell the underlying instrument.
Both the buyer and the seller can make a profit or suffer a loss, due to the fact
that the contract price (at which the underlying instrument is bought and sold) is
determined at closing of the contract. If the market price at the delivery date is
lower than the futures contract price, the buyer suffers a loss because he could
31
F
LOSS
PROFIT
E2P
LE1
have bought the instrument in the market at a lower price. He is now obliged,
according to the contract, to buy the underlying instrument at the higher price
specified in the contract. The opposite applies when the market value of the
underlying instrument is above the futures contract price. The buyer can now
buy the underlying instrument at the lower contract price, and sell the instrument
immediately at the higher market price, thus making an immediate profit.
The pay off for the buyer and the seller of the futures of the contracts are as
follows:
Pay-Off for a buyer of Futures
Payoff for a buyer of future
F- FUTURES PRICE
E1, E2 – SETTLEMENT PRICE
32
E2
PROFIT
LOSS
E1
P
L
CASE 1:- The buyer bought the futures contract at (F); if the futures price goes
to E1 then the buyer gets the profit of (FP).
CASE 2:- The buyer gets loss when the future price goes less then (F), if the
future price goes to E2 then the buyer gets the loss of (FL).
Pay-Off for a seller of Futures
Payoff for a seller of Future
F- FUTURES PRICE
E1, E2 – SETTLEMENT PRICE
33
CASE 1:- The seller sold the future contract at (f); if the future goes to E1 then
the seller gets the profit of (FP).
CASE 2: - The seller gets loss when the future price goes greater than (F); if the
future price goes to E2 then the seller gets the loss of (FL).
Options Option is a type of contract between two persons where one grants
the other the right to buy a specific asset at a specific price within a specific time
period. Alternatively the contract may grant the other person the right to sell a
specific asset at a specific price within a specific time period. In order to have
this right, the option buyer has to pay the seller or the option premium.
The assets on which option can be derived are stocks, commodities, indexes
etc. If the underlying asset is the financial asset, then the option are financial
option like stock options, currency options, index options etc, and if options like
commodity option.
Options contracts are instruments that give the holder of the instrument the right
to buy or sell the underlying asset at a predetermined price.
Properties of Options Options have several unique properties that set them apart from
other securities. The following are the properties of options:
Limited Loss
High Leverage Potential
Limited Life
Parties in an Option Contract1. Buyer of the Option:
The buyer of an option is one who by paying option premium buys the
right but not the obligation to exercise his option on seller/writer.
34
2. Writer/Seller of the Option:The writer of a call/put options is the one who receives the option
premium and is there by obligated to sell/buy the asset if the buyer
exercises the option on him.
Types of Options The options are classified into various types on the basis of various
variables. The following are the various types of options:
I) On the basis of the Underlying asset:On the basis of the
underlying asset the options are divided into two types:
Index Options: The Index options have the underlying asset as the
index.
Stock Options: A stock option gives the buyer of the option the right to
buy/sell stock at a specified price. Stock options are options on the
individual stocks, there are currently more than 50 stocks are trading in
this segment.
II) On the basis of the market movement :On the basis of the
marketmovement the options are divided into two types.
Call Option: A call options is bought by an investor when he seems that
the stock price moves upwards. A call option gives the holder of the
option the right but not the obligation to buy an asset by a certain date for
a certain price.
Put Option: A put option is bought by an investor when he seems that
the stock price moves downwards. A put option gives the holder of the
option right but not the obligation to sell an asset by a certain date for a
certain price.
35
III) On the basis of exercise of option:On the basis of the exercising of the
option, the options are classified into two categories.
American Option: American options are options that can be exercised at
any time up to the expiration date; most exchange-traded options are
American.
European Option: European options are options that can be exercised
only on the expiration date itself. European options are easier to analyze
than American option.
Call option:The following example would clarify the basics on Call Options.
Illustration 1:An investor buys one European Call option on one share of Reliance Petroleum
at a premium of Rs. 2 per share on 31 July. The strike price is Rs.60 and the
contract matures on 30 September. The payoffs for the investor on the basis of
fluctuating spot prices at any time are shown by the payoff table (Table 1). It
may be clear form the graph that even in the worst case scenario, the investor
would only lose a maximum of Rs.2 per share which he/she had paid for the
premium. The upside to it has an unlimited profits opportunity.
On the other hand the seller of the call option has a payoff chart completely
reverse of the call options buyer. The maximum loss that he can have is
unlimited though a profit of Rs.2 per share would be made on the premium
payment by the buyer.
36
Pay off from Call Buying/LongA European call option gives the following payoff to the investor:
Max (S - Xt, 0).The seller gets a payoff of:-max (S - Xt, 0) or min (Xt - S, 0).Notes:
S - Stock Price
Xt - Exercise Price at time 't1
C - European Call Option Premium
Payoff - Max (S - Xt, O)
37
Payoff from call Buying/Long
Net Profit - Payoff minus 'c'
Exercising the Call Option and its implications for the Buyer and the Seller:
The Call option gives the buyer aright to buy the requisite shares on a specific
date at a specific price. This puts the seller under the obligation to sell the
shares on that specific date and specific price. The Call Buyer exercises his
option only when he/ she feel it is profitable. This Process is called "Exercising
the Option". This leads us to the fact that if the spot price is lower than the strike
price then it might be profitable for the investor to buy the share in the open
market and forgo the premium paid. The implications for a buyer are that it is
his/her decision whether to exercise the option or not. In case the investor
expects prices to rise far above the strike price in the future then he/she would
surely be interested in buying call options. On the other hand, if the seller feels
that his shares are not giving the desired returns and they are not going to
perform any better in the future, a premium can be charged and returns from
selling the call option can be used to make up for the desired returns. At the end
of the options contract there is an exchange of the underlying asset. In the real
world, most of the deals are closed with another counter or reverse deal. There
38
is no requirement to exchange the underlying assets then as the investor gets
out of the contract just before its expiry.
Put OptionsThe European Put Option is the reverse of the call option deal. Here, there is a
contract to sell a particular number of underlying assets on a particular date at a
specific price. An example would help understand the situation a little better:
Illustration 2:An investor buys one European Put Option on one share of Reliance Petroleum
at a premium of Rs. 2 per share on 31 July. The strike price is Rs.60 and the
contract matures on 30 September. The payoff table shows the fluctuations of
net profit with a change in the spot price.
Payoff from Put Buying/Long
The payoff for the put buyer is: max (Xt - S, 0)The payoff for a put writer is: -max (Xt - S, 0) or min(S - Xt, 0)
39
Payoff from Put Buying/LongThese are the two basic options that form the whole gamut of transactions in the
options trading. These in combination with other derivatives create a whole
world of instruments to choose form depending on the kind of requirement and
the kind of market expectations.
Exotic Options are often mistaken to be another kind of option. They are nothing
but non-standard derivatives and are not a third type of option.
Options ClassificationsOptions are often classified as
In the money - These result in a positive cash flow towards the
investor
At the money - These result in a zero-cash flow to the investor
Out of money - These result in a negative cash flow for the
investor.
Naked Options: These are options which are not combined with
an offsetting contract to cover the existing positions.
Covered Options: These are option contracts in which the shares
are already owned by an investor (in case of covered call options)
40
and in case the option is exercised then the offsetting of the deal
can be done by selling these shares held.
Option PricingPrices of options are commonly depending upon six factors. Option's prices are
far more complex. These are the two basic options that form the whole gamut of
transactions in the options trading. These in combination with other derivatives
create a whole world of instruments to choose form depending on the kind of
requirement and the kind of market expectations. Exotic Options are often
mistaken to be another kind of option. They are nothing but non-standard
derivatives and are not a third type of option.
Options undertakings Stocks
Foreign Currencies
Stock Indices
Commodities
Others - Futures Options, are options on the futures contracts or
Underlying assets are futures contracts. The futures contract generally
matures shortly after the options expiration.
41
Effect of increase in the relevant parameter on option prices
Effect of increase in relevant parameter option prices1. Spot prices: In case of a call option the payoff for the buyer is max(S -
Xt, 0) therefore, more the Spot Price more is the payoff and it is favorable
for the buyer. It is the other ways round for the seller, more the Spot Price
higher are the chances of his going into a loss. In case of a put Option,
the payoff for the buyer is max (Xt - S, 0) therefore, more the Spot Price
more are the chances of going into a loss. It is the reverse for Put Writing.
2. Strike price: In case of a call option the payoff for the buyer is shown
above. As per this relationship a higher strike price would reduce the
profits for the holder of the call option.
3. Time to expiration: More the time to Expiration more favorable is the
option. This can only exist in case of American option as in case of
European Options the Options Contract matures only on the Date of
Maturity.
4. Volatility: More the volatility, higher is the probability of the option
generating higher returns to the buyer. The downside in both the cases of
Call and put is fixed but the gains can be unlimited. If the price falls
heavily in case of a call buyer then the maximum that he loses is the
premium paid and nothing more than that. More so he/ she can buy the
same shares form the spot market at a lower price. Similar is the case of
42
the put option buyer. The table shows all effects on the buyer side of the
contract.
5. Risk free rate of interest: In reality the r and the stock market is
inversely related. But theoretically speaking, when all other variables are
fixed and interest rate increases this leads to a double effect: Increase in
expected growth rate of stock prices discounting factor increases making
the price fall. In case of the put option both these factors increase and
lead to a decline in the put value. A higher expected growth leads to a
higher price
6. Taking the buyer to the position of loss in the payoff chart. The
discounting factor increases and the future value become lesser. In case
of a call option these effects work in the opposite direction/The first effect
is positive as at a higher value in the future the call option would be
exercised and would give a profit. The second affect is negative as is that
of discounting. The first effect is far more dominant than the second one,
and he overall effect is favorable on the call option.
7. Dividends: When dividends are announced then the stock prices on
ex-dividend are reduced. This is favorable for the put option and
unfavorable for the call option.
Call Option:C = SN (dl)-Xe"rtN(d2)
Put Option:p = xe^NC-oa-SNC-oa)
Where
C – Value of Call Option
S – Spot price of Stock
X – Strike Price
r – Annual Risk Free Return
t – Contract Cycle
43
TABLE: 1
HISTORICAL DATA OF NIFTY
44
45
Symbol Date Open High Low Close
NIFTY 1-Apr-14 5920 5920 58705890.8
5
NIFTY 4-Apr-14 59135984.6
5 5883 5973.4NIFTY 5-Apr-14 5972.5 5972.5 5903 5964.8NIFTY 6-Apr-14 5960 6000 5912 5941.4
NIFTY 7-Apr-14 5913.2 5960.4 59135931.8
5
NIFTY 8-Apr-14 5947 5955.3 58625879.3
5
NIFTY 11-Apr-14 5858 5872 58285834.5
5
NIFTY 13-Apr-14 5790 59805783.0
55968.0
5
NIFTY 15-Apr-14 5942 5950 5856.15865.3
5NIFTY 18-Apr-14 5822 5951 5760 5766.1
NIFTY 19-Apr-14 5750 58115740.5
5 5792
NIFTY 20-Apr-145825.5
55908.0
5 5802 5902.5
NIFTY 21-Apr-14 59255964.8
5 5914.3 5938.7
NIFTY 25-Apr-14 5944.5 5959 5916.55925.5
5
NIFTY 26-Apr-14 5905 5945 58305921.1
5
NIFTY 27-Apr-14 5944.5 5951.2 5858.85875.0
5
NIFTY 28-Apr-14 5883.45889.9
55815.5
5 5824.1
NIFTY 29-Apr-14 5815.8 5841.75733.3
5 5764
NIFTY 2-May-14 57995800.3
5 57175739.8
5
NIFTY 3-May-145714.7
5 5739 5574 5582.7
NIFTY 4-May-14 5556.9 56045523.0
55551.2
5
NIFTY 5-May-145520.4
55575.7
55455.5
55469.7
5
NIFTY 6-May-14 5490 55835477.2
55567.4
5NIFTY 9-May-14 5590 5668.8 5512.5 5570.3
NIFTY 10-May-145566.5
5 5614 5528.5 5555.8NIFTY 11-May-14 5555 5589.7 5535 5578.1
NIFTY 12-May-14 5549.85588.8
5 5485 5494.3
NIFTY 13-May-14 55005634.9
5 5479.7 5572.1
NIFTY 16-May-14 5540 5559 54925502.2
5
NIFTY 17-May-14 5495 55345436.3
55459.0
5
FIGURE: 1 NIFTY APRIL & MAY 2011
INTERPRETATION The above graphs and tabulations indicating performance of
index for the April to May 2014, where one can observe growth in first week,
later on we can see negative fluctuations till end of the April contract. When
analyzing factors for this increased inflation is one of the major factors.
To have inflation figures for end of May 2014. When compare
to 2013 the growth of inflation is 21.18%. When analyzed increased inflation in
India, the direct impact we can see in banking index as negative.
Based on inflation data and increased interest rates for the last
quarter by RBI, if an investor wants to sell banking stocks, for the given period,
investors will have more returns when they have shorts in the market in banking
stocks.
When analyzing April Nifty performance:
The index started at 5890 on 1st April 2014 and on 5th April
recorded high of 5964 and not able to support at that levels and has shown
continuous fall in the same month itself and closed least value 5554.9, here nifty
moved into bearish more than 10%. The major reason for the fall is inflation and
increased interest rates.
TABLE: 2HISTORICAL DATA OF INFOSYSTECH
46
Symbol Date Open High Low CloseINFOSYSTCH 1-Apr-14 3257.2 3262.7 3219.9 3242.9INFOSYSTCH 4-Apr-14
3259.85
3315.95
3259.85 3305.7
INFOSYSTCH 5-Apr-14 3277.2 3306.2 3251
3296.85
INFOSYSTCH 6-Apr-14 3291.3 3314.6
3270.15 3293.5
INFOSYSTCH 7-Apr-14 3270 3280
3257.25
3260.85
INFOSYSTCH 8-Apr-14
3268.85 3271 3228
3242.85
INFOSYSTCH 11-Apr-14 3220 3271 3201.2
3254.45
INFOSYSTCH 13-Apr-14
3216.15 3333
3216.15 3322.6
INFOSYSTCH 15-Apr-14 3310 3310 2991.4
3002.45
INFOSYSTCH 18-Apr-14
2949.65
2979.65 2903 2912
INFOSYSTCH 19-Apr-14 2900 2937 2887.1 2897.9INFOSYSTCH 20-Apr-14 2910 2935 2897.9
2914.45
INFOSYSTCH 21-Apr-14 2394 2949 2394 2919.2INFOSYSTCH 25-Apr-14 2920 2965 2916 2943.5INFOSYSTCH 26-Apr-14
2944.65
2956.95 2921.3
2944.75
INFOSYSTCH 27-Apr-14
2952.25 2962.8
2943.05
2951.65
INFOSYSTCH 28-Apr-14 2945
2956.75 2925 2930.7
INFOSYSTCH 29-Apr-14
2915.15 2926 2875
2891.55
INFOSYSTCH 2-May-14 2925 2932 2905.2 2918.2INFOSYSTCH 3-May-14
2912.65 2944.8
2882.45
2893.75
INFOSYSTCH 4-May-14 2879 2890.9
2835.05 2854.5
INFOSYSTCH 5-May-14 2850 2864.5 2818
2827.75
INFOSYSTC 6-May-14 2835.3 2889.7 2835.3 2873
47
HINFOSYSTCH 9-May-14 2890 2900
2852.15
2890.25
INFOSYSTCH 10-May-14 2888 2914 2859.1 2872.9INFOSYSTCH 11-May-14 2878.8 2905.8 2875
2889.75
INFOSYSTCH 12-May-14
2878.95 2894.7 2858
2865.45
INFOSYSTCH 13-May-14 2862 2901.9 2858.1 2871.5INFOSYSTCH 16-May-14 2860
2863.95
2832.55
2836.55
INFOSYSTCH 17-May-14 2900 2900
2820.05 2837.6
INFOSYSTCH 18-May-14 2829 2869.9 2790 2827.4INFOSYSTCH 19-May-14
2830.35
2842.05
2816.65 2828.5
INFOSYSTCH 20-May-14
2823.05 2848
2815.05 2836.6
INFOSYSTCH 23-May-14 2822.8
2835.95 2809
2819.25
INFOSYSTCH 24-May-14
2823.65
2841.85 2817.7 2823.6
INFOSYSTCH 25-May-14 2809 2810
2744.35 2774.9
INFOSYSTCH 26-May-14 2789.5
2797.95 2752.5 2773.3
48
FIGURE: 2: INFOSYSTECH
INFOSYSTECH FUTURE
CASE 1: Explaining about when expected fall in Infosystech results stocks for the particular period what kind of strategies will give best returns with minimum risk.
The above graph indicating performance of INFOSYSTECH for
the April 2014, when comparing with the index with Infosystech, it has recorded
life time high in the first week of November as 3303.5 and one can observe fall
till end of the contract. When expected this kind of situations in the market, an
investor can enter into put option by doing less risk for more returns.
The below tabulation showing working of INFOSYSTECH put
option when INFOSYSTECH performed in negative trend.
TABLE: 3INFOSYS 3300 PUT OPTION
Symbol Date Expiry
Strike
Price Open High Low CloseINFOSYSTCH 1-Apr-14 28-Apr-14 3300 131.5 131.5 131.5 131.5INFOSYSTCH 4-Apr-14 28-Apr-14 3300 97 105.7 79 86INFOSYSTCH 5-Apr-14 28-Apr-14 3300 101 115 85.4 86.85INFOSYSTCH 6-Apr-14 28-Apr-14 3300 90 98.45 80 89.3INFOSYSTCH 7-Apr-14 28-Apr-14 3300 105 106.8 95 102.95
INFOSYSTCH 8-Apr-14 28-Apr-14 3300108.9
5 118.9 104 108.75
INFOSYSTCH 11-Apr-14 28-Apr-14 3300124.4
5124.4
5 94 103.9
49
INFOSYSTCH 13-Apr-14 28-Apr-14 3300 101 101 59.05 64INFOSYSTCH 15-Apr-14 28-Apr-14 3300 69.2 309 69 296.65
INFOSYSTCH 18-Apr-14 28-Apr-14 3300372.2
5386.9
5 327.2 385.4
INFOSYSTCH 19-Apr-14 28-Apr-14 3300401.0
5408.3
5 372 398.2
INFOSYSTCH 20-Apr-14 28-Apr-14 3300378.4
5 395374.2
5 380INFOSYSTCH 21-Apr-14 28-Apr-14 3300 385.7 386 364 377.35
INFOSYSTCH 25-Apr-14 28-Apr-14 3300 358.7364.6
5 330 349.35
INFOSYSTCH 26-Apr-14 28-Apr-14 3300355.4
5356.3
5 355.4 356.35
INFOSYSTCH 27-Apr-14 28-Apr-14 3300 335.9350.95 335.9 339.3
INFOSYSTCH 28-Apr-14 28-Apr-14 3300 350373.25 350 368.25
50
FIGURE: 3: INFOSYSTECH 3300 PUT
TABLE: 4STRATEGY: long put strategy
51
Strategy : Buy Put Option
Current Infosystech 3302
Put Option Strike Price (Rs.) 3400
Mr. XYZ Pays Premium (Rs.) 69.0
Break Even Point (Rs.) [(Strike Price - Premium)] 3231
The payoff schedule
On expiry Infosys closes at Net Payoff from Put option (Rs.)
3100 231.55
3200 131.55
3300 31.55
3331.0 0
3400 -69
3500 -69
3600 -69
3700 -69
EXPLAINING LONG PUT STRATEGY WITH LIVE EXAMPLE:
Long put: meaning of long put equal to buying a put, a put gives right to sell, but
not have any obligation. We can use long put in two ways.
Exclusively for investment.
For hedging.
Exclusively for investment: when a product working as investment, it can
give profit as well as loss also. But here loss is limited and profit is unlimited.
Ex: on 14th April client code 142555 entered into Infosys 3300 put option at
Rs.69.0 when Infosys trading CMP of 3302. Lot size of Infosys is 125units. Total
investment is 8625 (125*69.0)
Profit and loss on long call:
52
On last day of the contract (29-Apr-2011), client closed the put premium at
Rs.368, where he got Profit of Rs 300. The above example is proving that an
option can work as pure investment product. An investment can give profit as
well as loss; in the above situation the product has given Profit.
FIGURE: 4: Profit and loss on long call
Data analysis & interpretation: with current data we can see more than
one combination to find return and risk.
Assume that entered in put option on same day with Rs.244.80 and closed
position on last day of contract at 250, here profit is Rs.5 equal to 2% on
investment.
This combination explaining even stocks falls also, some times will not give
more returns, when analyzing reason for this entering with high premiums is one
of the major reasons.
In the above example buying a put means, it gives a selling right and
assumption of selling is strike price minus premium.
53
Unlimited Profit
Limited loss
The payoff Chart Long Put
In the above example entered INFOSYSTECH 3100 strike price put option
entered in Rs.150, it means assumption of selling is 2974. This assumption,
when INFOSYSTECH trading at 3303on second day of April contract.
In the above examples PUT is high premium means assumption of selling is
lower levels so, here put has given least profit and future has given more profit.
2nd Combination
Here, when options trading with high premiums, investors has to wait for some
time. Assume that on 5th day of contract future sold at 3261, by keeping 100000
margin and put needs 7500 investment same day (60*125).
Working of returns:
INFOSYSTECH Future:
Future closed at 2928. On last day, profit on lot is Rs.333 (3261-2928)
Total return on investment = 333*125 = 41625.00
INFOSYSTECH Put option:
SBIN put closed at 250 on last day profit on lot is Rs.133 (170-37)
Total return on investment = 133*125 = 16625
The above combinations showing two different performances, and educating
investors about impact of high premiums in the starting week of the contract.
54
TABLE: 5INFOSYS 3300 CALL OPTION
Symbol Date Expiry
Strike Price
Open High Low Close
INFOSYSTCH 1-Apr-14 28-Apr-14 3300 70 75 58.1 61.95INFOSYSTCH 4-Apr-14 28-Apr-14 3300 74 94.4 70 85.8
INFOSYSTCH 5-Apr-14 28-Apr-14 330085.15 91.8 63.05 87.25
INFOSYSTCH 6-Apr-14 28-Apr-14 3300 80 93.35 70 80.9
INFOSYSTCH 7-Apr-14 28-Apr-14 330071.35 72.9 62.5 64.8
INFOSYSTCH 8-Apr-14 28-Apr-14 330064.65 67 46 53.7
INFOSYSTCH 11-Apr-14 28-Apr-14 3300 41.3 65.5 34.2 56.6
INFOSYSTCH 13-Apr-14 28-Apr-14 330042.35 92.85 37.1 84.95
INFOSYSTCH 15-Apr-14 28-Apr-14 330078.55 78.55 9 9.6
INFOSYSTCH 18-Apr-14 28-Apr-14 3300 9 9 3.65 3.95INFOSYSTCH 19-Apr-14 28-Apr-14 3300 3.95 4.5 2 2.25INFOSYSTCH 20-Apr-14 28-Apr-14 3300 3.5 3.5 1.25 1.5INFOSYSTCH 21-Apr-14 28-Apr-14 3300 1.05 1.5 0.95 1.05INFOSYSTCH 25-Apr-14 28-Apr-14 3300 0.25 1 0.05 0.75INFOSYSTCH 26-Apr-14 28-Apr-14 3300 0.35 0.65 0.35 0.4INFOSYSTCH 27-Apr-14 28-Apr-14 3300 0.3 0.45 0.15 0.3INFOSYSTCH 28-Apr-14 28-Apr-14 3300 0.1 0.25 0.05 0.05
55
0
10
20
30
40
50
60
70
80
90
100INFOSYSTECH 3300CALL
INFOSYSTECH 3300CALL
FIGURE: 5: INFOSYSTECH 3300CALL
TABLE: 6
LONG CALL STRATEGY
Strategy :Long call Option
Current Infosystech 3302Call Option Strike Price (Rs.) 3300
Mr. XYZ Pays Premium (Rs.) 78.55Break Even Point (Rs.) [(Strike Price+ Premium)] 3378.55
56
The payoff Schedule
On expiry Nifty closes at Net Payoff from Call Option (Rs.)
3100 -78.553200 -78.553300 -78.553378.55 03400 21.453500 121.453600 221.45
FIGURE: 6: LONG CALL STRATEGY
57
Unlimited Profit
The payoff chart (Long Call)
Unlimited Profit
Limited Loss
EXPLAINING LONG CALL STRATEGY WITH LIVE EXAMPLE:
Long call:Meaning of long call equal to buying a call, a call gives right to buy, but not
have any obligation. We can use long call in two ways.
Exclusively for investment.
For hedging.
Exclusively for investment: When a product working as investment, it can give profit as well as loss also.
But here loss is limited and profit is unlimited.
Ex: on 14th April client code 142555 entered into Infosys 3300 call option at
Rs.78.55 when Infosys trading CMP of 3302. Lot size of Infosys is 125units.
Total investment is 9818.75 (125*78.55)
Profit and loss on long call: On last day of the contract (29-Apr-2011), client closed the call at Rs.0, where
he got loss of Rs 78.55. The above example is proving that an option can
work as pure investment product. An investment can give profit as well as
loss; in the above situation the product has given loss. An investment can give
loss also, but here only the premium is the loss.
Analysis: Previous eight years history has proved that maximum times Infosys shown
positive performance on share price before results and negative performance
after results.
If an investor wants to invest for short term, when he has bullish view on a
stock he can have three options,
1. Buying equity shares
2. Buying a future
3. Buying a call option
58
But option one and two linked with high investments and risk is also high, but
the main objective, with minimum risk, investor should gain more returns than
1st and 2nd options.
Buying a call in special situation, loss is only the premium paid by the
investor.
Ex: Based above tabulation, if investor entered into 3300 Infosys April call
option with premium of Rs.85 on starting day of month contract, the profit and
loss would be as mentioned below on after results of contract.
After results day of contract Infosys 3300 call option settlement price is 9.6
and the approximate loss are 75.4 which are equal to 84.647% for the given
period.
Loss% = total loss on investment *100 investment
= 74.5 *100 85
= 87.647% approximately
Conclusion: the above example proving in special situations options will give
the best returns than any other product. In the above 3 options, no product
can gives more than 100% returns, i.e., concluding options are best
investment.
59
TABLE: 7SHORT CALL STRATEGY
Strategy : Sell Call Option
Current Infosystech 3300
Call Option Strike Price (Rs.)
Mr. XYZ receives
Premium (Rs.) 78.54
Break Even Point (Rs.)(Strike Price +Premium) 3378.54
The payoff schedule
On expiry Nifty closes at Net Payoff from the Call Options(Rs.)
3000 78.54
3100 78.54
3200 78.54
3300 78.54
60
3378.54 0
3400 -21.46
3500 -121.46
3600 -221.46
FIGURE: 7: SHORT CALL STRATEGY
Selling an option is high risk, here option writer/seller have the obligation to
bear unwanted exposure. Another bearish strategy is to sell a call Option. As
a call Seller, you will receive Premium. For example, if you sell
INFOHSYSTECH April 3300 call Option for Rs 78.54; on 15th April 2014 you
will earn an Income of Rs 78.54 on the day of the transaction. You will
however face a risk that you might have to pay the difference between 3300
and the closing price of INFOHSYSTECH scrip on the last Thursday of
APRIL. For example, if INFOHSYSTECH were to close on that day at Rs
2928.8, you will be asked to pay Rs 372.2. After setting of the Premium
received of Rs 78.54, the net loss will be Rs 294. If on the other hand,
INFOHSYSTECH closes above Rs 3300 (as per your bearish view), the entire
income of Rs 150 would belong to you.
61
Limited Profit
Unlimited Loss
The Payoff Chart (Short Call)
As a call Seller, you are required to put up Margins. These margins are
calculated by the exchange using a software program called Span. The
margins are likely to be between 20 to 35% of the Contract Value. As a call
Seller, you have a limited profit, unlimited loss profile which is a high risk
strategy. If time passes and INFOHSYSTECH remains wherever it is (say Rs
2750), you will be very happy. Passage of time helps the Sellers as value of
the Option declines over time.
Explaining above strategy with live example. Client 142444 sold
INFOHSYSTECH call on 15th April at Rs 78.4, when stock trading at 3300.
Working profit and loss for his strategy
Table showing price records for INFOHSYSTECH 3300 April 2011 CALL
OPTION
Symbol Date Expiry Strike Price
Open
High Low Close
INFOSYSTCH 15-Apr-11 28-Apr-11 3300
78.55
78.55 9 9.6
INFOSYSTCH 21-Apr-11 28-Apr-11 3300 1.05 1.5 0.95 1.05INFOSYSTCH 28-Apr-11 28-Apr-11 3300 0.1 0.25 0.05 0.05
According to above details client got the loss of Rs 294 due to fall down in the
market and he is being as a call seller.
TABLE: 8
SHORT PUT STRATEGY
62
FIGURE: 8: SHORT PUT STRATEGY
Selling an option is high risk, here option writer/seller have the obligation to
bear unwanted exposure. Another bullish strategy is to sell a Put Option. As a
Put Seller, you will receive Premium. For example, if you sell INFOSYSTECH
April 3300 Put Option for Rs 69; you will earn an Income of Rs 69 on the day
of the transaction. You will however face a risk that you might have to pay the
difference between 3300 and the closing price of INFOSYSTECH scrip on the
last Thursday of January. For example, if INFOSYTECH were to close on that
day at Rs 3100, you will be asked to pay Rs 131. After setting of the Premium
received of Rs 69, the net loss will be Rs 131. If on the other hand,
INFOSYSTECH closes above Rs 3300 (as per your bullish view), the entire
income of Rs 131 would belong to you.
As a Put Seller, you are required to put up Margins. These margins are
calculated by the exchange using a software program called Span. The
margins are likely to be between 20 to 25% of the Contract Value. As a Put
63
Limited profit
Unlimited Loss
The payoff Chart Short Put
The payoff schedule
On expiry Infosystech Closes at
Net Payoff from the Put Option (Rs.)
2900 -330.83000 -230.83100 -130.83200 -30.83230.8 03300 69.23400 69.23500 69.2
Seller, you have a limited profit, unlimited loss profile which is a high risk
strategy.
5.1SUMMER FINDINGS1) Derivative market is growing very fast in the Indian Economy. The
turnover of Derivative Market is increasing year by year in the India’s
largest stock exchange NSE. In the case of index future there is a
phenomenal increase in the number of contracts. But whereas the
turnover is declined considerably. In the case of stock future there was
a slow increase observed in the number of contracts whereas a decline
was also observed in its turnover. In the case of index option there was
a huge increase observed both in the number of contracts and
turnover.
2) After analyzing data it is clear that the main factors that are driving the
growth of Derivative Market are Market improvement in communication
facilities as well as long term saving & investment is also possible
through entering into Derivative Contract. So these factors encourage
the Derivative Market in India.
3) Impact of inflation interest rates and financial results fluctuate stock
market operations, few sectors shown positive and few performs in
negative.
4) Increased inflation is negative impact on banking and decreased
inflation positive impact on banking, proved in April, May banking
index.
5) Options trades with high premiums in starting week of contract, and
given example, if entered with high premium what would be the
disadvantage.
6) In high volatility markets options will give more returns with less risk.
7) In the month of April 2014, Infosys call option given 84.67% loss
64
8) On 13th January, Infosys announced financial results, and before
announcing the result day i.e. 15th April every investor and every
financial advisor in the company have bearish view on the stock based
on historical performance on results day.
9) In the month of December Banking shown negative and IT shown
positive performance. Sometimes these two sectors showing positive
correlation and sometimes negative correlation.
10) IT sector has international exposure, few of Indian IT stocks trades in
international markets also, so the impact will be there in IT sector.
11) Derivatives give best return when compared to equity market, but
have high risk also.
12) Hedging minimizes the risk/loss, but every time it’s not possible.
13) In option loss is limited profits is unlimited.
14) The derivatives products give the investor an option or choice whether
to exercise to contract or not.
15) An option gives the choice to the investors to either exercise his right
or not.
65
5.2 SUGGESTIONS
Speculation should be discouraged. There must be more
derivative instruments aimed at individual investors. SEBI should conduct
seminars regarding the use of derivatives to educate individual investors.
1. Derivative market is highly ill- famed among the investor. Thus it is
required to provide in depth knowledge of the market to investors.
2. Strategies should be evaluated daily for better returns and less risk.
3. Theoretical price of an option should be found out using option pricing
models and those options whose price is less than theoretical price
should be used for formulation of strategy.
4. By using a hedging strategy an investor can recover some of his losses
and can also make profit.
5. When the movement and volatility of market or scrip is not known at
that time investor should use only options.
6. The investors before in to the derivatives contract (Especially in future
&option) should be clearly known about their capacity to take risk & the
risk involve in the trading in future &option contract.
7. If the investors or trader is taking the position in the future market. He
must be first clear about the risk & return profile of the future. The
66
future buyer may make unlimited profit or unlimited loss, depending on
the price of the assets in the delivery market.
8. If the price of the stock purchased falls due fall in the index, the loss
arising from the cash market will be compensated by the profit
achieved by the selling index futures.
5.3 CONCLUSION Although derivative market is growing in a faster rate
still it is not so popular in Indian financial market. Due to lack of
awareness or risk averseness, Indian investors don’t show interest to
use derivatives to hedge in equity market. Not with standing the
endorsement of derivatives by financial economists and business
persons, there is a widespread belief among regulators, bureaucrats
and politicians that derivatives are employed mainly for speculation
purposes, and they accentuate the volatility of the underlying cash
markets.
Many in the profession, however, disagree vehemently
with the view that derivatives accentuate volatility in the cash markets.
On the contrary volatility in the underlying cash market declines with
the introduction of derivatives. Since hedging opportunities prove
valuable only if the underlying cash markets are volatile, derivatives are
introduced only when the underlying asset prices become more
volatile.
From the above project following points are proved-
The underlying stock values changes according to the news.
Depending on underlying stock prices the derivative values also
changes. By doing above analysis we can know when to buy, at
what time to sell and how much risk we can take.
67
As there is just loss of premium/margin when compared to
equity, people prefer Future and Options. Above project has
done practical analysis on three contracts for nifty.
5.4 LIMITATIONSHowever, the study is going to be a research project, but it definitely
has some of the limitation, which is as follows:
1. The Time constraint is the important limitation of this study.
2. Due to the shallow knowledge about the topic, detailed study
could not be conducted.
3. The cost is also limited factor of this study
4. Not possible to study more strategies
5. The data collected is completely restricted to the NIFTY,50
hence this analysis cannot be taken universally
68
BIBLIOGRAPHYTEXT BOOKS:
David. A. Dubofsky & Thomas. W. Miller, Jr., “Derivatives Valuation and Risk Management”
Prasanna chandra Financial Risk Management & Derivatives
M.Y.Khan Indian Financial System – 9th Edition
R. Mahajan Futures & Options
Rene.M.Stulz Risk Management & Derivatives
Jhon C Hull Option, futures and other derivatives (NCFM)
WEBSITES:
www.indianderivatives.comwww.nseindia.comwww.bseindia.comwww.networthdirect .comwww.sebi.org.inwww.indianmart.com
NEWS PAPERS:
Economic Times
Business Line
Times of India
Financial Express
JOURNALS:
Indian journal of finance (volume-6 number-3), March 2015.
The IUP journal of APPLIED finance (volume-18 number1), January
2015.
Portfolio organizer by IUP publication.
69
Journal of Accounting and Finance.
CHARATED SECRETARY (volume-xvii number-02), February.
70