'A Study on Futures and Potions\r'

'A STUDY ON FUTURES AND POTIONS dispatch wedge shapemitted in partial fulfillment for the award of the acknowledge of MASTER OF BUSINESS ADMINISTRATION solution I hereby decl ar that this Project Report titled, â€Å"A STUDY ON THE DERIVATIVES” submitted by me to the Department OF BUSINESS ADMINISTRATION, XXXX and is a bonafide work downheartedstairs transfern by me and it is non submitted to both otherwise University or Institution for the award of any leg diploma / certificate or make any survey before. Name and key in of the StudentSignature of the student date : ACKNOWLEDGEMENTI wish to control my sincere deep sense of gratitude and excessively thank my guide XXX, Faculty of salary for his signifi foott suggestions and fiscal aid in e precise(prenominal) aspect to accomplish the project work. His die hard encouragement, ever finising patience and keen lodge in in discussions take benefited me to the completion that plentynot be spanned by words. I take my recreation to acknowledge XXXX for the facilities provided and constant encouragement. Finally I express bows to e genuinely champion who ar involved with this project. circumscribe INTRODUCTION METHODOLOGY 1 FUTURES 2 weftS ANALYSIS OF THE STUDYSUMMARY AND CONCLUSIONS BIBLIOGRAPHY INTRODUCTION Nature of the hassle: The turnover of the melodic concern diversifys has been trem discontinueously addition from last 10 years. The come up of trades and the human body of investors, who ar participating, abide change magnituded. The investors atomic number 18 ordain to reduce their take note, so they ar want for the essay c arment beams. Prior to SEBI abolishing the BADLA establishment, the investors had this system as a source of trim back the seek, as it has many troubles the standardizeds of no strong margining system, unclear spillage visit stamp and generating forbid party danger.In view of this problem SEBI abolished the BADLA syste m. After the abolition of the BADLA system, the investors ar want for a hedging system, which could reduce their portfolio riskiness. SEBI imagination the presentment of the deriveds transaction, as a outset step it has set up a 24 member committee on a lower floor the chairmanship of Dr. L. C. Gupta to pose the appropriate regulatory fashion model for contrastingial gear occupation in India, SEBI accept the recommendations of the committee on may 11, 1998 and go offonic the phased installation of the variousial gears work beginning with live conduct top executive forthcoming tenses. on that point ar many investors who ar volitioning to trade in the differential gear fragment, beca do of its advantages like express dismission and out refine nedeucerk by nonrecreational the at a lower place coatd bonuss. IMPORTANCE OF THE STUDY: To evaluate the net income/ neediness slur of cream toter and excerpt source. OBJECTIVES OF THE STUDY: ? To analyze the derivatives grocery store in India. ? To analyze the operations of futures and survivals. ? To shit hold out the realise/ bolshy impersonate of the filling source and plectron pallbe ber. ? To theater of operations about risk commission with the assist of derivatives. SCOPE OF THE STUDY:The study is limited to â€Å"Derivatives” with special reference to futures and plectrums in the Indian context and the Hyderabad form modify has been taken as a representative exemplification for the study. The study elicit’t be express as on the whole perfect. each alteration may come. The study has except made a humble campaign at evaluating derivatives foodstuff only in Indian context. The study is not ground on the international perspective of derivatives commercialises, which exists in NASDAQ, NYSE and so on LIMITATIONS OF THE STUDY: The by-line ar the limitations of this study. The scrip chosen for digest is acres BANK OF INDIA a nd the tweet taken is bound cc5 ending oneness-calendar month trim back. ? The data sedate is all restricted to the STATE BANK OF INDIA of howevert on cc5; hence this outline cannot be taken as universal. METHODOLOGY The emergence of the trade for derivative products, most notably frontwards, futures and survival of the fittests, can be traced back to the bequeathingness of risk-averse economic agents to fight down themselves a overhearst un veritable(prenominal)(a)ties arising out of fluctuations in summation charges.By their very nature, the financial foodstuffs argon marked by a very high point in age of volatility. Through the persona of derivative products, it is assert adapted to partially or fully ravish determine risks by lockingâ€in addition sets. As doers of risk management, these broadly speaking do not influence the fluctuations in the profound plus equipment casualtys. However, by locking-in summation embodys, derivative products min imize the trespass of fluctuations in summation termss on the gain groundability and hard bills flow situation of risk-averse investors. Derivatives ar risk management instruments, which derive their foster from an vestigial addition.The profound plus can be bullion, baron, sh ar, bonds, hard funds, interest etc. situates, securities familys, companies and investors to hedge risks, to gain access to cheaper property and to make do good, use derivatives. Derivatives ar likely to grow plain at a faster browse in future. DEFINITION: Derivative is a product whose set is derived from the measure out of an profound asset in a stupefyual manner. The underlie asset can be truth, forex, commodity or any other asset. Securities bowdlerises (Regulation) Act, 1956 (SC(R) A) defines â€Å"derivative” to include †1.A security derived from a debt instrument, sh be, loan whether secured or unsecured, risk instrument or snub for differences or any other f orm of security. 2. A pact which derives its evaluate from the footings, or index of expenses, of profound securities. PARTICIPANTS: The undermentioned ternary broad categories of participants in the derivatives market. HEDGERS: Hedgers face risk associated with the wrong of an asset. They use futures or selections markets to reduce or hap this risk. SPECULATORS: Speculators wish to bet on future movements in the outlay of an asset.Futures and survival of the fittests irons can depict through them an extra leverage; that is, they can addition both the potential gains and potential passing gamees in a speculative venture. ARBITRAGEURS: Arbitrageurs be in business to take advantage of a discrepancy amid expenses in devil different markets. If, for example, they see the futures value of an asset getting out of line with the funds wrong, they impart take offsetting powers in the 2 markets to lock in a earnings. FUNCTIONS OF DERIVATIVES securities industry: The succeeding(a) be the mingled functions that ar performed by the derivatives markets.They argon: ? scathes in an organized derivatives market reflect the learning of market participants about the future and direct the charges of vestigial to the perceived future level. ? Derivatives market helps to transfer risks from those who be in possession of them be grimaces may not like them to those who have an appetite for them. ? Derivative craft acts as a catalyst for brisk entrepreneurial activity. ? Derivatives markets help increase savings and investment in the long run. Types of derivatives: the interest are the diverse types of derivatives. They are: Forwards:A forward deal is a customized boil down among ii entities, where liquidation takes place on a particular date in the future at today’s pre-agreed cost. Futures: A futures dilute is an agreement amid two parties to fuck off or cover an asset at a certain time in the future at a certain out lay. natural selections: selections are of two types †holler outs and institutionalises. Calls give the dealer the right only when not the obligation to get a habituated quantity of the cardinal asset, at a given terms on or before a given future date. go downs give the purchaser the right, but not the obligation to sell a given quantity of the implicit in(p) asset at a given cost on or before a given date.Warrants: natural selections generally have lives of upto one year; the majority of pickaxs traded on survivals re-sentencings having a maximal maturity of nine months. Longer-dated survivals are makeed warrants and are generally traded over-the-counter. LEAPS: The acronym LEAPS means long Equity Anticipation Securities. These are options having a maturity of upto three years. Baskets: Basket options are options on portfolios of profound assets. The underlying asset is usually a piteous fair of a basketful of assets. Equity index options are a form of basket options. Swaps:Swaps are private agreements between two parties to re-sentencing bills flows in the future according to a prearranged formula. They can be regarded as portfolios of forward promises. The two commonly used swaps are: Interest pasture swaps: These entail swapping only the interest link exchange flows between the parties in the like currency. _ Currency swaps: These entail swapping both of import and interest between the parties, with the money flows in one direction being in a different currency than those in the opposite Direction. Swaptions: Swaptions are options to pervert or sell a swap that will make up operative at the departure of the options.Thus a swaption is an option on a forward swap. RATIONALE BEHIND THE training OF DERIVATIVES: Holding portfolio of securities is associated with the risk of the possibility that the investor may realize his returns, which would be much slighter than what he expected to get. thither are sundry(a) fact ors, which affect the returns: 1. Price or dividend (interest). 2. Some are internal to the firm like †? Industrial policy ? perplexity capabilities ? Consumer’s preference ? Labor radiate, etc. These forces are to a large extent controllable and are termed as non self-opinionated risks.An investor can easily manage such(prenominal) non-systematic by having a well †diversify portfolio spread across the companies, industries and groups so that a loss in one may easily be compensated with a gain in other. There are yet other types of influences which are impertinent to the firm, cannot be controlled and affect large number of securities. They are termed as systematic risk. They are: 1. Economic 2. Political 3. Sociological changes are sources of systematic risk. For instance, inflation, interest enumerate, etc. their install is to cause expenditures of borderingly all mortal origins to move together in the kindred manner.We hence quite often find stock e quipment casualtys falling from time to time in spite of company’s earnings rising and vice versa. rationale behind the development of derivatives market is to manage this systematic risk, liquidity and liquidity in the sense of being able to steal and sell relatively large measurements quickly without substantial equipment casualty concessions. In debt market, a large position of the total risk of securities is systematic. Debt instruments are similarly finite invigoration securities with limited marketability due to their minuscular size relative to many common stocks.Those factors party favour for the purpose of both portfolio hedging and speculation, the introduction of a derivative security that is on some broader market rather than an individualist security. India has vibrant securities market with strong sell participation that has rolled over the years. It was until belatedly basi speaky gold market with a facility to function forward positions in activel y traded ‘A’ group scrips from one settlement to another by rendering the requisite margins and borrowing some money and securities in a separate birth forward session held for this purpose.However, a hire was felt to introduce financial products like in other financial markets humanness over which are characterized with high course of derivative products in India. Derivative products suffer the user to transfer this expenditure risk by looking in the asset footing there by minimizing the impact of fluctuations in the asset outlay on his balance sheet and have ensure notes flows. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, shares, bonds, currency etc.DERIVATIVE SEGMENT AT NATIONAL carnation EXCHANGE: The derivatives part on the exchange commenced with S&P CNX Nifty list futures on June 12, cc07. The F&O segment of NSE provides trading facilities for t he following derivative segment: 1. indicant base Futures 2. Index Based alternatives 3. Individual banal Options 4. Individual line of products Futures |COMPANY NAME |CODE | hardening SIZE | |ABB Ltd. ABB |200 | |Associated Cement Co. Ltd. |ACC |750 | |Allahabad patois |ALBK |2450 | |Andhra bank |ANDHRABANK |2 three hundred | |Arvind Mills Ltd. ARVINDMILL |2 one hundred fifty | |Ashok Leyland Ltd |ASHOKLEY |9550 | |Bajaj Auto Ltd. |BAJAJAUTO |200 | | believe of Baroda |BANKBARODA |1400 | |Bank of India |BANKINDIA |1900 | |Bharat Electronics Ltd. BEL |550 | |Bharat think over Co Ltd |BHARATFORG |200 | |Bharti Tele-Ventures Ltd |BHARTI |1000 | |Bharat legal Electricals Ltd. |BHEL | three hundred | |Bharat Petroleum confederation Ltd. |BPCL |550 | |Cadila healthcare hold in |CADILAHC 500 | |Canara Bank |CANBK |1600 | | snow Textiles Ltd |CENTURYTEX |850 | |Chennai Petroleum Corp Ltd. |CHENNPETRO |950 | |Cipla Ltd. |CIPLA |1000 | |Kochi Refineries Ltd |COCHINREFN |1300 | |Colgate Palmolive (I) Ltd. COLGATE |1050 | |Dabur India Ltd. |DABUR |1800 | |GAIL (India) Ltd. |GAIL |cl0 | | capital Eastern ecstasy Co. Ltd. |GESHIPPING |1350 | |Glaxosmithkline Pharma Ltd. |GLAXO |300 | |Grasim Industries Ltd. |GRASIM |175 | |Gujarat Ambuja Cement Ltd. GUJAMBCEM |550 | |HCL Technologies Ltd. |HCLTECH |650 | |Ho employ breeding pay kitty Ltd. |HDFC |300 | |HDFC Bank Ltd. |HDFCBANK |400 | |Hero Honda Motors Ltd. |HEROHONDA |400 | |Hindalco Industries Ltd. |HINDALC0 |150 | |Hindustan Lever Ltd. HINDLEVER |2000 | |Hindustan Petroleum Corporation Ltd. |HINDPETRO |650 | |ICICI Bank Ltd. |ICICIBANK |700 | |Industrial development bank of India Ltd. |IDBI |2400 | |Indian Hotels Co. Ltd. |INDHOTEL |350 | |Indian Rayon And Industries Ltd | INDRAYON |500 | |Infosys Technologies Ltd. INFOSYSTCH |100 | |Indian Overseas Bank |IOB |2950 | |Indian crude oil Corporation Ltd. |IOC |600 | |ITC Ltd. |ITC |150 | |Jet Airways (India) Ltd. |JETAIRWAYS |200 | |Jindal vane & P ower Ltd |JINDALSTEL |250 | |Jaiprakash Hydro-Power Ltd. JPHYDRO |6250 | |Cummins India Ltd |KIRLOSKCUM |1900 | |LIC Housing Finance Ltd |LICHSGFIN |850 | |Mahindra & Mahindra Ltd. |M&M |625 | |Matrix Laboratories Ltd. |MATRIXLABS |1250 | |Mangalore Refinery and Petrochemicals Ltd. MRPL |4450 | |Mahanagar describe Nigam Ltd. |MTNL |1600 | |National Aluminium Co. Ltd. |NATIONALUM |1150 | |Neyveli Lignite Corporation Ltd. |NEYVELILIG |2950 | |Nicolas Piramal India Ltd |NICOLASPIR |950 | |National Thermal Power Corporation Ltd. NTPC |3250 | |Oil & Natural Gas Corp. Ltd. |ONGC |300 | |Oriental Bank of Commerce |ORIENTBANK |600 | |Patni data processor System Ltd |PATNI |650 | |Punjab National Bank |PNB |600 | |Ranbaxy Laboratories Ltd. RANBAXY |200 | |Reliance Energy Ltd. |REL |550 | |Reliance pileus Ltd |RELCAPITAL |1100 | |Reliance Industries Ltd. | trust |600 | |Satyam Com launcher function Ltd. SATYAMCOMP |600 | |State Bank of India |SBIN |500 | |Shipping Corpora tion of India Ltd. |SCI |1600 | |Siemens Ltd |SIEMENS |150 | |Sterlite Industries (I) Ltd |STER |350 | |Sun Pharmaceuticals India Ltd. SUNPHARMA |450 | |Syndicate Bank |SYNDIBANK |3800 | |Tata Chemicals Ltd |TATACHEM |1350 | |Tata Consultancy run Ltd |TCS |250 | |Tata Power Co.Ltd. |TATAPOWER |800 | |Tata Tea Ltd. |TATATEA |550 | |Tata Motors Ltd. |TATAMOTORS |825 | |Tata Iron and Steel Co. Ltd. |TISCO |675 | |Union Bank of India |UNIONBANK |2100 | |UTI Bank Ltd. UTIBANK |900 | |Vijaya Bank |VIJAYABANK |3450 | |Videsh Sanchar Nigam Ltd |VSNL |1050 | |Wipro Ltd. |WIPRO |300 | |Wockhardt Ltd. |WOCKPHARMA |600 | REGULATORY FRAMEWORK:The trading of derivatives is rangeed by the provide contained in the SC ( R ) A, the SEBI Act, the and the prescripts framed there under the rules and byelaws of stock exchanges. Regulation for Derivative handicraft: SEBI set up a 24 member committed under Chairmanship of Dr. L. C. Gupta develop the appropriate regulatory framework for derivative trad ing in India. The committee submitted its storey in blemish 1998. On May 11, 1998 SEBI accepted the recommendations of the committee and ratified the phased introduction of Derivatives trading in India beginning with nisus Index Futures.SEBI also pass he â€Å"Suggestive bye-laws” recommended by the committee for regulation and control of trading and settlement of Derivatives contracts. The provisions in the SC (R) A govern the trading in the securities. The amendment of the SC (R) A to include â€Å"DERIVATIVES” indoors the ambit of ‘Securities’ in the SC (R ) A made trading in Derivatives possible within the framework of the Act. 1. Any exchange fulfilling the eligibility criteria as convinced(p) in the L. C. Gupta committee report may apply to SEBI for consecrate of recognition under Section 4 of the SC (R) A, 1956 to deject Derivatives craft.The derivatives exchange/segment should have a separate governing council and representation of tradin g / change members shall be limited to maximum of 40% of the total members of the governing council. The exchange shall regulate the sales practices of its members and will obtain approval of SEBI before start of Trading in any derivative contract. 2. The exchange shall have stripped 50 members. 3. The members of an animated segment of the exchange will not automatically become the members of the derivative segment. The members of the derivative segment need to fulfill the eligibility conditions as lay down by the L.C. Gupta Committee. 4. The clearing and settlement of derivates trades shall be through a SEBI approved unclutter Corporation / Clearing house. Clearing Corporation / Clearing hearth complying with the eligibility conditions as lay down By the committee have to apply to SEBI for grant of approval. 5. Derivatives broker/dealers and Clearing members are needed to seek registration from SEBI. 6. The Minimum contract value shall not be little than Rs. 2 Lakh. Exchange s should also submit expatiate of the futures contract they purpose to introduce. 7.The trading members are required to have qualified approved user and sales person who have passed a certification programme approved by SEBI. FUTURES DEFINITION: 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 determine. To facilitate liquidity in the futures contract, the exchange specifies certain standard features of the contract. The standardized items on a futures contract are: ? standard of the underlying ? Quality of the underlying ? The date and the month of delivery ? The units of worth quotations and minimum impairment change ? Locations of settlementTYPES OF FUTURES: On the fanny of the underlying asset they derive, the futures are split into two types: ? 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 cas h settlement and the settlement scathe of the future is the closing price of the underlying security. ? 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 cessation date of the contract.Parties in the Futures Contract: There are two parties in a future contract, the Buyer and the marketer. The vendee of the futures contract is one who is LONG on the futures contract and the vendor of the futures contract is one who is pathetic on the futures contract. The pay off for the purchaser and the vender of the futures contract are as follows. PAYOFF FOR A vendee OF FUTURES: [pic] fountain 1: The vendee bought the future contract at (F); if the futures price goes to E1 then the buyer gets the arrive at of (FP). type 2: The buyer gets loss when the future price goes little(prenominal)(prenominal) tha n (F), if the futures price goes to E2 then the buyer gets the loss of (FL).PAYOFF FOR A SELLER OF FUTURES: [pic] F †FUTURES expenditure E1, E2 †SETTLEMENT expenditure. baptistry 1: The Seller interchange the future contract at (f); if the futures price goes to E1 then the Seller gets the cabbage of (FP). outcome 2: The Seller gets loss when the future price goes greater than (F), if the futures price goes to E2 then the Seller gets the loss of (FL). MARGINS: beachs are the deposits, which reduce counter party risk, prepare in a futures contract. These margins are collected in value to eliminate the counter party risk. There are three types of margins: sign Margin:Whenever a futures contract is signed, both buyer and seller are required to post initial margin. two buyer and seller are required to make security deposits that are mean to guarantee that they will infact be able to fulfill their obligation. These deposits are Initial margins and they are often refe rred as performance margins. The core of margin is roughly 5% to 15% of total purchase price of futures contract. scaling to Market Margin: The process of adjusting the equity in an investor’s account in order to reflect the change in the settlement price of futures contract is cognize as MTM Margin.Maintenance margin: The investor must appreciation the futures account equity able to or greater than certain percentage of the tally deposited as Initial Margin. If the equity goes little(prenominal) than that percentage of Initial margin, then the investor receives a call for an additional deposit of cash know as Maintenance Margin to bring the equity up to the Initial margin. Role of Margins: The role of margins in the futures contract is explained in the following example. S sold a Satyam February futures contract to B at Rs. 300; the following table shows the prepare of margins on the contract.The contract size of Satyam is 1200. The initial margin amount is say Rs. 2 0000, the alimentation margin is 65% of Initial margin. | daylight | damage OF SATYAM |EFFECT ON emptor (B) |EFFECT ON SELLER (S) |REMARKS | | | |MTM |MTM | | | | |P/L |P/L | | | | |Bal. in Margin |Bal. n Margin | | | | | | | | |1 | | | | | | | | | |Contract is entered and| | |300. 00 | | |initial margin is | | | | | |deposited. |2 | | | | | | | | | | | | | |+13,200 | | | | | | |-13,200 |B got profit and S got | | |311(price increased) | |+13,200 |loss, S deposited | |3 | | | |maintenance margin. | | | | | | | | | | | |B got loss and | | | | | |deposited maintenance | |4 | |-28,800 | |margin. | | |+15,400 |+28,800 | | | | | | | | | |287 | | |B got profit, S got | | | | | |loss. Contract settled| | | | | |at 305, totally B got | | | |+21,600 | |profit and S got loss. | | | |-21,600 | | | | | | | | | |305 | | | | price the Futures: The fair value of the futures contract is derived from a model known as the be of Carry model. This model gives the fair value of the futures contract. Cost of Carry Model: F=S (1+r-q) t Where F †Futures Price S †full stop price of the underlie r †Cost of Financing q †pass judgment Dividend Yield T †Holding Period. FUTURES language: Spot price: The price at which an asset trades in the snoop market. Futures price: The price at which the futures contract trades in the futures market.Contract cycle: The halt over which a contract trades. The index futures contracts on the NSE have one-month, two-months and three-month release cycles which expire on the last atomic number 90 of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three-month expiry is introduced for trading. expiration date: It is the date contract in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Contract size:The amount of asset that has to be delivered under one contract. For instance, the contract size on NSE’s futures market is 200 Nifties. tooshie: In the context of financial futures, fundament can be defined as the futures price minus the bonk price. There will be a different dry land for each delivery month for each contract. In a expression market, foundation will be positive. This reflects that futures prices unremarkably exceed spot prices. Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is stipendiary to finance the asset little the income earned on the asset. Open Interest:Total dramatic long or short positions in the market at any specific time. As total long positions for market would be equal to short positions, for tally of open interest, only one side of the contract is counted. creamS DEFINITION: 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 specified time arrest. rather the contract may grant the other person the right to sell a specific asset at a specific price within a specific time finis. In order to have this right, the option buyer has to pay the seller of the option subsidy. The assets on which options can be derived are stocks, commodities, indexes etc.If the underlying asset is the financial asset, then the options are financial options like stock options, currency options, index options etc, and if the underlying asset is the non-financial asset the options are non-financial options like commodity options. PROPERTIES OF pickaxS: Options have several(prenominal) unique properties that set them apart from other securities. The following are the properties of options: ? Limited qualifying ? High Leverage Potential ? Limited Life PARTIES IN AN altern ative generate: 1. Buyer of the Option: The buyer of an option is one who by nonrecreational option bonus buys the right but not the obligation to make his option on seller/writer. . Writer/Seller of the Option: The writer of a call/ post options is the one who receives the option gift 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 rudimentary asset: On the basis of the underlying asset the options are carve up 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 onlinely to a greater extent(prenominal) than 50 stocks are trading in this segment. II. On the basis of the market movement: On the basis of the market movement the options are divided into two types. They are: ? scratch OPTION: A call options is bought by an investor when he seems that the stock price moves upwards. A call option gives the bearer of the option the right but not the obligation to buy an asset by a certain date for a certain price. ? devote OPTION: A swan option is bought by an investor when he seems that the stock price moves downwards. A trust option gives the toter of the option right but not the obligation to sell an asset by a certain date for a certain price. III. On the basis of exercise of Option:On the basis of the employment 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 options. PAY-OFF profile FOR BUYER OF A CALL OPTION: The pay-off of a buyer options depends on the spot price of the underlying asset. The following graph shows the pay-off of buyer of a call option: S- take on priceOTM †step forward of the money SP - indemnity/LossATM †At the MoneyE1 †Spot price 1 ITM †In The Money E2 †Spot price 2 elder†profit at spot price E1 CASE 1: (Spot price > start Price) As the spot price (E1) of the underlying asset is much than than expunge price (S). The buyer gets the profit of (SR), if price increases to a greater extent than E1 than profit also increase more than SR. CASE 2: (Sport price < off Price) As the spot price (E2) of the underlying asset is less than bear price (s). The buyer gets loss of (SP), if price goes down less than E2 than also his loss is limited to his insurance subsidy (SP). PAY †OFF PROFILE FOR SELLER OF A CALL OPTION:The pay-of f of seller of the call option depends on the spot price of the underlying asset. The following graph shows the pay-off of seller of a call option: [pic] S-Strike priceITM †In the Money SP †Premium/profitATM †At the Money E1-Spot price 1OTM †give away of The Money E2 -Spot price 2 SR-profit at spot price E1 CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying asset is less than score price (S). The seller gets the profit of (SP), if the price decreases less than E1 than also profit of the seller does not exceed (SP). CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than postulate price (S).The seller gets loss of (SR), if price goes more less than E2 than the loss of the seller also increase more than (SR). PAY-OFF PROFILE FOR BUYER OF A assign OPTION: The payoff of buyer of the option depends on the spot price of the underlying asset. The following graph shows the pay off of the buyer of a call option: [pic] S-Strike priceITM-In The Money SP-Premium/profitOTM-Out of The Money E1-Spot price 1ATM-At The Money E2-Spot price 2 SR-profit at spot price E1 CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying asset is less than strike price (S). The buyer gets the profit of (SR), if price decreases less than E1 than the profit also increases more than (SR). CASE 2: (Spot price > Strike price)As the spot price (E2) of the underlying asset is more than strike price (s), the buyer gets loss of (SP), if price goes more than E2 than the loss of the buyer is limited to his tribute (SP). PAY-OFF PROFILE FOR SELLER OF A correct OPTION: The pay off of seller of the option depends on the spot price of the underlying asset. The following graph shows the pay-off of seller of a put option: [pic] S-Strike priceITM-In The Money SP-Premium/profitATM-At The Money E1-Spot price 1OTM-Out of The Money E2-Spot price 2 SR-profit at spot price E1 CASE 1: (Spot pri ce < Strike price) As the spot price (E1) of the underlying asset is less than strike price (S), the seller gets the loss of (SR), if price decreases less than E1 than the loss also increases more than (SR). CASE 2: (Spot price > Strike price)As the spot price (E2) of the underlying asset is more than strike price (S), the seller gets profit of (SP), if price goes more than E2 than the profit of the seller is limited to his premium (SP). FACTORS AFFECTING THE scathe OF AN OPTION: The following are the various factors that affect the price of an option. They are: Stock price: The pay-off from a call option is the amount by which the stock price exceeds the strike price. Call options therefore become more valuable as the stock price increases and vice versa. The pay-off from a put option is the amount; by which the strike price exceeds the stock price. Put options therefore become more valuable as the stock price increases and vice versa. Strike price:In the case of a call, as the strike price increases, the stock price has to make a larger upward move for the option to go in-the â€money. Therefore, for a call, as the strike price increases, options become less valuable and as strike price decreases, options become more valuable. age to expiration: Both Put and Call American options become more valuable as the time to expiration increases. Volatility: The volatility of n a stock price is a measure of uncertain about future stock price movements. As volatility increases, the line up that the stock will do very well or very low increases. The value of both Calls and Puts therefore increase as volatility increase.Risk-free interest rate: The put option prices decline as the risk †free rate increases where as the prices of calls always increase as the risk †free interest rate increases. Dividends: Dividends have the effect of reducing the stock price on the ex dividend date. This has a banish effect on the value of call options and a positiv e affect on the value of put options. PRICING OPTIONS The stern Scholes formulas for the prices of European Calls and puts on a non-dividend paying stock are: CALL OPTION: C = SN (D1)-Xe-rtN(D2) PUT OPTION: P = Xe-rtN(-D2)-SN (-D2) C †VALUE OF CALL OPTION S †SPOT PRICE OF STOCK X †STRIKE PRICE r †ANNUAL RISK allay RETURN †CONTRACT CYCLE D1 †(ln(s/x) +(r+ )/2) t)/ D2 †D1- Options linguistic process: Strike Price: The price specified in the options contract is known as the Strike price or shape price. Option Premium: Option premium is the price paid by the option buyer to the option seller. Expiration Date: The date specified in the options contract is known as the expiration date. In-The-Money Option: An in the money option is an option that would transmit to a positive cash inflow to the holder if it is exercised immediately. At-The-Money Option: An at the money option is an option that would lead to zero cash flow if it is exercised immediate ly. Out-Of-The-Money Option:An out of the money option is an option that would lead to a negative cash flow if it is exercised immediately. Intrinsic Value of an Option: The intrinsic value of an option is ITM, if option is ITM. If the option is OTM, its intrinsic value is ZERO. Time Value of an Option: The time value of an option is the difference between its premium and its intrinsic value. DESCRIPTION OF THE METHOD: The following are the travel involved in the study. 1. Selection of the scrip: The scrip selection is done on a random basis and the scrip selected is assent COMMUNICATIONS. The lot size of the scrip is 500. Profitability position of the option holder and option writer is studied. 2. Data collection:The data of the RELIANCE COMMUNICATIONS has been collected from the â€Å"The Economic generation” and the internet. The data consists of the March contract and the period of data collection is from 30th celestial latitude 2008 to 31st January 2008. 3. Analysis: The compend consists of the tabular matter of the data assessing the profitability positions of the option holder and the option writer, representing the data with graphs and making the interpretations using the data. ANALYSIS ANALYSIS The objective of this analysis is to evaluate the profit/loss position of option holder and option writer. This analysis is based on the sample data, taken RELIANCE COMMUNICATIONS scrip. This analysis considered the March ending contract of the SBI.The lot size of SBI is 500. The time period in which this analysis is done is from 30/12/2007 To 31/01/2008 Price of SBI in the Cash Market. | run across |MARKET PRICE | | | | |30-Dec-07 |685. 1 | |31-Dec-07 |714. 65 | |1-Jan-08 |695. 6 | |2-Jan-08 |706. 4 | |3-Jan-08 |717. 1 | |4-Jan-08 |713. 45 | |7-Jan-08 |726. 6 | |8-Jan-08 |724. 05 | |9-Jan-08 |720. 85 | |10-Jan-08 |742. 1 | |11-Jan-08 |736. | |14-jan-08 |734. 1 | |15-Jan-08 |731. 75 | |16-Jan-08 |728 | |17-Jan-08 |726. 2 | |18-Jan-08 | | | |727. 8 | | | | |21-Jan-08 |722. 7 | |22-Jan-08 |693. 25 | |23-Jan-08 |657. 7 | |24-Jan-08 |664. 4 | |28-Mar-08 |665. 6 | |29-Jan-08 |641. 7 | |30-Jan-08 |661. 05 | |31-Jan-08 |654. 8 | pic] The closing price of SBI at the end of the contract period is 654. 80 and this is considered as settlement price. The following table explains the amount of transaction between option holder and option writer. ? The send-off newspaper tower explains the trading date. ? The second column explains the market price in cash segment on that date. ? The call column explains the call/put options which are considered. both call/put has three sub columns. ? The first column consists of the premium value per share of the contracts, second column consists of the flock of the contract, and the third column consists of total premium value paid by the buyer. ? give the axe PAYOFF FOR CALL OPTION HOLDERS AND WRITERS |MARKET PRICE |CALLS | peck (‘000) |PREMIUM (‘000) | gather TO HOLDER| terminal realise TO | gelt PROFIT TO | | | | | |(‘000) |HOLDER (‘000) |BUYER (‘000) | | | | | | | | | |654. 8 |640 |199. 5 |3634. 15 |2952. 6 |-681. 55 |681. 55 | |654. 8 |660 |1463 |21600. 35 |0 |-21600. 35 |21600. 35 | |654. |680 |2008 |51831. 53 |0 |-51831. 525 |51831. 525 | |654. 8 |700 |3297 |85603. 45 |0 |-85603. 45 |85603. 45 | |654. 8 |720 |3796. 5 |74881. 93 |0 |-74881. 925 |74881. 925 | |654. 8 |740 |2309. 5 |30208. 4 |0 |-30208. 4 |30208. 4 | OBSERVATIONS AND FINDINGS: ? sextette call options are considered with six different strike prices. ? The true market price on the expiry date is Rs. 654. 80 and this is considered as utmost settlement price. The premium paid by the option holders whose strike price is distant and greater than the live market price have paid high amounts of premium than those who are near to the flowing market price. ? The call option holders whose strike price is less than the current market price are tell to be In-The-Money. The calls with strike price 640 are verbalise to be In-The-Money, since, if they exercise they will get profits. ? The call option holders whose strike price is less than the current market price are said to be Out-Of-The-Money. The calls with strike price of 660, 680,700,720,740 are said to be Out-Of-The-Money, since, if they exercise, they will get losses. [pic] FINDINGS:The premium of the options with strike price of 700 and 720 is high, since most of the period of the contract the cash market is moving around 700 mark. [pic] FINDINGS: ? The contracts with strike price 660, 680, 700, 720, 740 get no profit, since their strike price is more than the settlement price. ? The contract with strike price 640 gets the profit. NET PAY OFF OF PUT OPTION HOLDERS AND WRITERS. |MARKET PRICE |PUTS |VOLUME (‘000) |PREMIUM (‘000) |PROFIT TO HOLDER |NET PROFIT TO HOLDER |NET PROFIT TO WRITER| | | | | |(‘000) |(‘000) |(‘000) | | | | | | | | | |654. |600 |25 |47. 625 |0 |-47. 625 |47. 625 | |654. 8 |640 |323. 5 |993. 5 |0 |-993. 5 |993. 5 | |654. 8 |660 |1239. 5 |9506. 575 |6445. 4 |-3061. 175 |3061. 175 | |654. 8 |680 |1399. 5 |21894 |35267. 4 |13373. 4 |-13373. 4 | |654. 8 |700 |1858 |30871. 28 |83981. 6 |53110. 325 |-53110. 325 | |654. |720 |1468. 5 |23727. 83 |95746. 2 |72018. 375 |-72018. 375 | | | | | | | | | OBSERVATIONS AND FINDINGS: ? Six put options are considered with six different strike prices. ? The current market price on the expiry date is Rs. 654. 80 and this is considered as the final settlement price. ? The premium paid by the option holders whose strike price is far and greater than the current market price have paid high amount of premium than those who are near to the current market price. The put option holders whose strike price is more than the current market price are said to be In-The-Money. The puts with strike price 660,680,700,720 are said to be In-The-Money, since, if they exercise they will get profits. ? The put option holder s whose strike price is less than the current market price are said to be Out-Of-The-Money. The puts with strike price of 600,640 are said to be Out-Of-The-Money, since, if they exercise their puts, they will get losses. [pic] FINDINGS: ? The premium of the option with strike price 700 is higher(prenominal) when compared to other strike prices. This is because of the movement of the cash market price of the SBI between 640 and 720. [pic] FINDINGS: The put option holders whose strike price is more than the settlement price are In-The-Money. ? The put options whose strike price is less than the settlement price are Out-Of-The-Money. DATA OF SBI THE FUTURES OF THE JANUARY calendar month |DATE |FUTURES CLOSING PRICE (Rs. ) | hard currency CLOSING PRICE (Rs. ) | | | | | |30-Dec-07 |689. 6 |685. 1 | |31-Dec-07 |720. 65 |714. 65 | |1-Jan-08 |700. 5 |695. 6 | |2-Jan-08 |710. 9 |706. 4 | |3-Jan-08 |720. 85 |717. 1 | |4-Jan-08 |716. 85 |713. 45 | |7-Jan-08 |729. 2 |726. 6 | |8-Jan-08 |728. 25 |724. 05 | |9-Jan-08 |723. 35 |720. 5 | |10-Jan-08 |745. 3 |742. 1 | |11-Jan-08 |741. 35 |736. 9 | |14-Jan-08 |738. 95 |734. 1 | |15-Jan-08 |735. 7 |731. 75 | |16-Jan-08 |733. 15 |728 | |17-Jan-08 |730. 75 |726. 2 | |18-Jan-08 |732. |727. 8 | |21-Jan-08 |725. 25 |722. 7 | |22-Jan-08 |695 |693. 25 | |23-Jan-08 |660. 1 |657. 7 | |24-Jan-08 |666. 7 |664. 4 | |28-Jan-08 |667. 75 |665. 6 | |29-Jan-08 |642. 7 |641. 7 | |30-Jan-08 |662. 5 |661. 05 | |31-Jan-08 |655. 95 |654. 8 | [pic] OBSERVATIONS AND FINDINGS: The cash market price of the SBI is moving along with the futures price. ? If the buy price of the futures is less than the settlement price, then the buyer of the futures get profit. ? If the selling price of the futures is less than the settlement price, then the seller regain losses. SUMMARY, CONCLUSIONS AND RECOMMENDATINONS SUMMARY ? Derivatives market is an innovation to cash market. Approximately its daily turnover reaches to the equal stage of cash market. Presently the o perational scrips in futures are 89 and in options segment are 62. ? In cash market the profit/loss of the investor depends on the market price of the underlying asset. The investor may fix abundant profits or he may incur colossal losses. But in derivatives segment the investor enjoys huge profits with limited downside. ? In cash market the investor has to pay the total money, but in derivatives the investor has to pay premiums or margins, which are some percentage of total money. ? Derivatives are mostly used for hedging purpose. ? In derivative segment the profit/loss of the option holder/option writer is purely depended on the fluctuations of the underlying asset. CONCLUSIONS In bullish market the call option writer incurs more losses so the investor is suggested to go for a call option to hold, where as the put option holder suffers in a bullish market, so he is suggested to write a put option. ? In bearish market the call option holder will incur more losses so the investor is suggested to go for a call option to write, where as the put option writer will get more losses, so he is suggested to hold a put option. ? In the above analysis the market price of State Bank of India is having low volatility, so the call option writers enjoy more profits to holders. RECOMMENDATIONS ? The derivative market is saucily started in India and it is not known by every investor, so SEBI has to take steps to create awareness among the investors about the derivative segment. In order to increase the derivatives market in India, SEBI should revise some of their regulations like contract size, participation of FII in the derivatives market. ? Contract size should be minimized because small investors cannot afford this much of huge premiums. ? SEBI has to take further steps in the risk management mechanism. ? SEBI has to take measures to use efficaciously the derivatives segment as a tool of hedging. BIBLIOGRAPHY BIBLIOGRAPHY BOOKS: FUTURES AND OPTIONS †N. D. VOHRA, B. R. BAGRI DERIVATIVES CORE MODULE WORKBOOK †NCFM MATERIAL FUTURES AND OPTIONS †R. MAHAJAN WEBSITES: www. nseindia. com www. equitymaster. com www. peninsularonline. com discussion EDITIONS: THE ECONOMIC TIMES BUSINESS flexure\r\n'