Copy of Anil Derivatives Projets

8/14/2019 Copy of Anil Derivatives Projets

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Central Institute of Business Management Research & Development, Nagpur-25

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FINAL PROJECT

USE OFFUTURE & OPTIONS IN BEARISH MARKET

Under the guidance of

Mr. Prasish Barua BY-

(Technical Analyst) ANIL CHAHAR

Central Institute of Business Management Research and

Development, Nagpur


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PROJECT REPORT

ON

UUssee ooffFFuuttuurreess && OOppttiioonnss iinn BBeeaarriisshh MMaarrkkeett

IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE DEGREE OF

MASTER OF BUSINESS ADMINISTRATION

BY

Mr. ANIL KAPOOR CHAHAR

UNDER THE GUIDANCE OF

Mr. PRASHANT BARUA

Central Institute of Business Management Research Development

Nagpur

2008-2010


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CERTIFICATE

This is to certify that Mr. ANIL KAPOOR CHAHAR is a bonafide student of central Institute Of

Business Management Research & Development Nagpur. And studying in MBA part IV and has

completed his final project atMotilal Securities Pvt. Ltd. And Submitted Report on topic Use of

Future & Options In Bearish Market under my complete guidance and supervision.

This project report is submitted to RTM Nagpur University in partial fulfillment of academic

requirement for the Degree of Master of Business Administration during the academic year

2009-2010.

I find the work comprehensive, complete and of sufficiently high standard to warrant its

presentation.

Guide Director

Mr. ANUP SUCHAK Prof. SHYAM SUKLA

Date:

Place: Nagpur


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DECLARATION

I ANIL KAPOOR CHAHAR a student of M.B.A. Part IV of CIBMRD, Nagpur her declare that,

the project entitledUUssee ooffFFuuttuurreess && OOppttiioonnss iinn BBeeaarriisshh MMaarrkkeett or Part there of has not been

previously submitted by me for any other Degree or diploma of any University or Scientific

Organization. The Project is the result of my bonafide work and source of literature used and all

assistance received during the course of investigation have duly acknowledged.

Date:

Place: Nagpur ANIL KAPOOR CHAHAR


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ACKNOWLEDGEMENT

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

of my study.

It is indeed a great pleasure to express my sincere thanks and great sense of gratitude to Mr.

ANUP SUCHAK for his invaluable guidance, timely help and suggestion and constant

encouragement during my project work.

I take opportunity to express sincere thanks to teaching and non teaching staff of central

Institute Of Business Management Research &Development Nagpur.

Also Im thankful to the branch head Mr.Prashant Pimplwar, my mentor Mr. Prashish Bharne,

and Mr.harish at motilal oswal securities ltd. Nagpur Branch.

Lastly Im thankful to my Parents and Friends for keeping my spirit alive through the

course of my project.

Date:-

Place: - Nagpur Anil Kapoor Chahar


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1.0 Introduction to der ivatives

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 zin asset prices. By their very nature, the financial

markets are marked by a very high degree of volatility

The following factors have been driving the growth of financial derivatives:

Increased volatility in asset prices in financial markets,

Increased integration of national financial markets with the international markets,

Marked improvement in communication facilities and sharp decline in their costs,

Development of more sophisticated risk management tools, providing economicagents a wider choice of risk management strategies, and

Innovations in the derivatives markets, which optimally combine the risks andreturns over a large number of financial assets, leading to higher returns, reduced

risk as well as trans-actions costs as compared to individual financial assets.


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1.2 Types of derivatives

The most commonly used derivatives contracts are forwards, futures and options which we shall

discuss in detail later. Here we take a brief look at various derivatives contracts that have come

to be used.

Forwards: A forward contract is a customized contract between two entities, wheresettlement takes place on a specific date in the future at todayspre-agreed price.

Futures: A futures contract is an agreement between two parties to buy or sell an asset ata 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.

Options: Options are of two types - calls and puts. Calls give the buyer the right but notthe obligation to buy a given quantity of the underlying asset, at a given price on or

before a given future date. Puts give the buyer the right, but not the obligation to sell a

given quantity of the underlying asset at a given price on or before a given date.

Swaps: Swaps are private agreements between two parties to exchange cash flows in thefuture according to a prearranged formula. They can be regarded as portfolios of forward

contracts.


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Myths about der ivatives

In less than three decades of their coming into vogue, derivatives markets have become the most

important markets in the world. Financial derivatives came into the spotlight along with the rise

in uncertainty of post-1970, when US announced an end to the Bretton Woods System of fixed

exchange rates leading to introduction of currency derivatives followed by other innovations

including stock index futures. Today, derivatives have become part and parcel of the day-to-day

life for ordinary people in major parts of the world. While this is true for many countries, there

are still apprehensions about the introduction of derivatives. There are many myths about

derivatives but the realities that are different especially for Exchange traded derivatives, which

are well regulated with all the safety mechanisms in place.

What are these myths behind derivatives?

Derivatives increase speculation and do not serve any economic purpose Indian Market is not ready for derivative trading Disasters prove that derivatives are very risky and highly leveraged

instruments

Derivatives are complex and exotic instruments that Indian investors willfind difficulty in understanding

existing capital market safer than Derivatives?


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Futures and options

Futures and options represent two of the most common form of "Derivatives". Derivatives are

financial instruments that derive their value from an 'underlying'. The underlying can be a stock

issued by a company, a currency, Gold etc., The derivative instrument can be traded

independently of the underlying asset.

The value of the derivative instrument changes according to the changes in the value of the

underlying.

Derivatives are of two types -- exchange traded and over the counter.

Exchange traded derivatives, as the name signifies are traded through organizedexchanges around the world. These instruments can be bought and sold through theseexchanges, just like the stock market. Some of the common exchange traded derivative

instruments are futures and options.

Over the counter (popularly known as OTC) derivatives are not traded through theexchanges. They are not standardized and have varied features. Some of the popular OTC

instruments are forwards, swaps, swaptions etc.


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Futures

A 'Future' is a contract to buy or sell the underlying asset for a specific price at a pre-determined

time. If you buy a futures contract, it means that you promise to pay the price of the asset at a

specified time. If you sell a future, you effectively make a promise to transfer the asset to the

buyer of the future at a specified price at a particular time. Every futures contract has the

following features:

Buyer Seller Price Expiry

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

The difference between the price of the underlying asset in the spot market and the futuresmarket is called 'Basis'. (As 'spot market' is a market for immediate delivery) The basis is usuallynegative, which means that the price of the asset in the futures market is more than the price inthe spot market. This is because of the interest cost, storage cost, insurance premium etc., That is,if you buy the asset in the spot market, you will be incurring all these expenses, which are notneeded if you buy a futures contract. This condition of basis being negative is called as'Contango'.

Sometimes it is more profitable to hold the asset in physical form than in the form of futures. Fore.g.: if you hold equity shares in your account you will receive dividends, whereas if you holdequity futures you will not be eligible for any dividend.


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When these benefits overshadow the expenses associated with the holding of the asset, the basisbecomes positive (i.e., the price of the asset in the spot market is more than in the futuresmarket). This condition is called 'Backwardation'. Backwardation generally happens if the price

of the asset is expected to fall.

It is common that, as the futures contract approaches maturity, the futures price and the spotprice tend to close in the gap between them i.e., the basis slowly becomes zero.


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Options

Options contracts are instruments that give the holder of the instrument the right to buy or sellthe underlying asset at a predetermined price. An option can be a 'call' option or a 'put' option.

A call option gives the buyer, the right to buy the asset at a given price. This 'given price' iscalled 'strike price'. It should be noted that while the holder of the call option has a right todemand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if

the buyer wants to buy the asset, the seller has to sell it. He does not have a

similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer.Here the buyer has the right to sell and the seller has the obligation to buy.

So in any options contract, the right to exercise the option is vested with the buyer of thecontract. The seller of the contract has only the obligation and no right. As the seller of thecontract bears the obligation, he is paid a price called as 'premium'. Therefore the price that ispaid for buying an option contract is called as premium.


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OBJECTIVES OF

USE OF FUTURE & OPTIONS IN BEARISH MARKET

To understand the concept and benefits of Hedging.

Hedging principles used in Futures and Options market.

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

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


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METHODOLOGY

To achieve the object of studying the stock market data ha been collect

Research methodology carried for this study can be two types

1. Primary

2. Secondary

PRIMARY

The data, which is being collected for the time and it is the original data is this

Project the primary data has been taken from BSE, Motilal Oswal and guide of the project.

SECONDARY

The secondary information is mostly from

Websites books, Journals, etc.


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Methodology of the project starts with:

The first phase we are trained and they teach us different things about futures and optionsmarket.

After that I have gone through the data related to Futures and Options market tounderstand the main problem that people were facing during recession and due to that

were not able to cope up with their losses.

Ive understood that people were in losses because they were looking Futures as aninvestment segment but not as a hedging tool and they were not aware of options market.

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

losses.

The next part knows the pattern of the Futures and Options market. How they move with the

correspondence to the market movement and also the economy.

Get the knowledge of technical as well as fundamental methods. Observe the patterns of the Futures and Options market used individually and mutually.


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LIMITATIONS

The various Limitations are:--

Lack of awareness about Futures and Options segment: - Since the area isnot known before it takes lot of time in convincing people to start investing in Futures

and Options market for hedging purpose.

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

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

penetration is poor in India.

Some respondents are unwilling to talk: - Some respondents either do not havetime or willing does not respond as they are quite annoyed with the adverse market

conditions they faced so far.

Misleading concepts: - Some people think that Derivatives are too risky and justanother name of gamble but they dont know its not at all that risky for long investors.


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Company

Profile


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Company Profi le

The story of Motilal Oswal Securities Ltd goes back many years, when Mr. Motilal Oswal andMr. Raamdeo Agrawal met each other as students in a Mumbai suburban hostel in the earlyeighties. Both the young chartered accountants hailing from a rural & an unpretentiousbackground had a common dream viz 'to build a professional organization with strong value

systems, to provide reliable & honest investment advice to investors'. Thus was born their firstenterprise called "Prudential Portfolio Services" in 1987.


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Motilal Oswal Securities Ltd. was founded in 1987 as a small sub-broking unit, with just twopeople running the show. Focus on customer-first-attitude, ethical and transparent businesspractices, respect for professionalism, research-based value investing and implementation ofcutting-edge technology has enabled us to blossom into an almost 2000 member team.

SUCCESS MANTRA FOR MOSL :

The success story of MOSL is driven by 8 success sutras adopted by it namely: Trust, Integrity,

Dedication, Commitment, Enterprise, Hard work and Team play, Learning and

Innovation, Empathy and Humility. These are the values that bind success with MOSL.

M ission Statement:

To be a well-respected and preferred global financial services organization enabling wealthcreation for all our customers.Today MOSL is a well diversified financial services firm offering a range of financial productsand services such as

Wealth Management

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

MOSL has a diversified client base that includes retail customers (including High Net worthIndividuals), mutual funds, foreign institutional investors, financial institutions and corporateclients. MOSL are headquartered in Mumbai and as of March 31st, 2009, had a network spread

over548 cities and towns comprising 1,289 Business Locations operated by our BusinessPartners and us. As at March 31st, 2009, we had 541372 registered customers.

In 2006, the Company placed 9.48% of its equity with two leading private equity investors basedout of the USNew Vernon Private Equity Limited and Bessemer Venture Partners.
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The company got listed on BSE and NSE on September 9, 2007. The issue which was priced atRs.825 per share (face value Rs.5 per share) got overwhelming response and was subscribed27.18 times in turbulent market conditions. The issue gave a return of 21% on the date of listing.

As of end of financial year 2008, the group net worth was Rs.7 bn. and market capitalization as

of March 31, 2008 was Rs.19 bn.

For year ended March 2008, the company showed a strong top line growth of 91% to Rs.7 bn. AsCompared to Rs.3.68 bn. last year. New businesses like investment banking, asset managementand fund based activities have contributed to this growth.

Credit rating agency Crisil has assigned the highest rating of P1+ to the Companys short-termdebt program.

Shareholding Pattern at on 31st December 08

As of December 31st, 2008; the total shareholding of the Promoter and Promoter Group stood

at 70.37%. The shareholding of instituti ons stood at 10.07% and non-i nstituti ons at 19.56%.

Their Business StreamsOur businesses and primary products and services are:

Wealth M anagement

Financial planning for individual, family and business wealth creation and management needs.These are provided to customers through our Wealth Management service called Purple

Broking & Distri bution services

Equity (cash and der ivati ves) Commodity Br oking Portfoli o Management Services Distri bution of financial products Financing Depository Services I PO distri bution


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

Commodity Broking

Through Motilal Oswal Commodities Broker (P) Ltd our fully owned subsidiary; we providecommodity trading facilities and related products and services on MCX and NCDEX. Besidesaccess to the best of research in the form of Daily Fundamentals & Technical Reports on highlytraded commodities, our clients also get access to our exclusive Customized Trading Advice onboth the trading platforms. We offer these services through our branches, Business Partnerlocations, the internet and mobile channels

Portf oli o Management Services

Motilal Oswal Portfolio Management Services offer a range of investments solutions throughdiscretionary services. We at Motilal Oswal have helped create wealth for our customers through

our Portfolio Management Services. Our knowledge of the markets together with ourunderstanding of our customers and their risk profiles has helped us design a range of portfolioofferings for our clients. These include the Value Strategy, Bulls Eye Strategy, Trillion DollarOpportunity Strategy and Focused Strategy Series I. As of March 31st, 2009, the Assets UnderManagement of our various portfolio schemes stood at Rs.4.77 bn.

Motilal Oswal group has applied to the regulatory bodies for a license to operate as a DomesticAsset Management Company (Mutual Fund) and we expect to begin operations soon.
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I nstitutional Equities

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

I nvestment Banking

We offer financial advisory services relating to mergers and acquisitions (domestic and cross-border), divestitures, restructurings and spin-offs through Motilal Oswal Investment AdvisorsPrivate Ltd. (MOIAPL)

We also offer capital raising and other investment banking services such as the management ofpublic offerings, private placements (including qualified institutional placements), rights issues,share buybacks, open offers/delisting and syndication of debt and equity.

MOIAPL has closed 23 transactions in 2007-08 worth US$ 1.8 billion and had 18 mandates inhand as at March 31, 2008.

Pri vate Equi ty

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

The fund is aimed at providing growth capital to small and medium enterprises in India, withinvestments typically in the range of US$3 million to US$7 million.
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Principal Strategies Group

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

Focus on Research

Research is the solid foundation on which Motilal Oswal Securities advice is based. Almost 10%of revenue is invested on equity research and we hire and train the best resources to becomeadvisors. At present we have 22 equity analysts researching over 27 sectors. From afundamental, technical and derivatives research perspective; Motilal Oswal's research reportshave received wide coverage in the media (over a 1000 mentions last year). Our consistentefforts towards quality equity research has reflected in an increase in the ratings and rankingsacross various categories in the Asia Money Brokers Poll over the years

Our unique Wealth Creation Study, authored by Mr. Raamdeo Agrawal, Managing Director, isnow in its 13th year. Investors keenly await this annual study for the wealth of information it has

on the companies that created wealth during the preceding five years.

Awards and Accolades

Motilal Oswal Financial Services has received many accolades in the year gone by. Some ofthem are:

Rated Best Overall Country Research for a Local Brokerage in the 2007 Asia MoneyBrokers poll

Rated Indias top broking house in terms of total number of trading terminals by the Dun& Bradstreet survey

Rated Outstanding Commodity Broking House-2007 by Global India
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Corporate off ices & Branches

BRANCH-HEAD OFFICE

Palm Spri ng Centre,

2nd Floor, Palm Court Complex,New Link Road, Malad (West),

Mumbai 400 064,

Maharashtra, India.

LOCATION OF SIP COMPANY

Motilal Oswal Securities Ltd.

Pukhraj House (Super Franchisee),

VIP Road, Dharampeth,

Nagpur.-440010, Maharashtra.

Tel.:0712-2554495, 3291306, 3291304


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FUTURES

AND

OPTIONS


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FUTURES AND OPTIONS

Futures & options are derivatives, which derive their values from equity as their underlying.

Hence our Equity Advisory Group (EAG) equipped with all the required skills and

understanding of Equity Derivatives, will act as your advisors in futures & options segment

as well to help you take informed trading decisions.

Why Futures and Options

Derivatives instruments are primarily hedging tools. Clients can be assisted in protecting the

downside risk to their portfolio using appropriate combination of options. Our advisory is

skilled to help you in maximizing your gains from your existing corpus using numerous

strategies based on the direction and intensity of the views. Derivatives give an ability to

leverage; given the risk appetite clients can extrapolate their gains with the timely assistance

of our advisory. The Equity Advisor doesnt stop at just that, he goes a step further to ensure

that your trades are settled and traded with proper margin in your account in a timely

manner. This allows us to give you a convenient single window service and your advisor

becomes the single point contact for all your equity related matters.

You can avail of our services from all ourBusiness locations and through E broking across
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History of F utures and Options

H istory of futures

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

I ntroduction to Futures:

Futures markets were designed to solve the problems that exist in forward markets. A futurescontract is an agreement between two parties to buy or sell an asset at a certain time in the futureat a certain price. But unlike forward contracts, the futures contracts are standardized andexchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certainstandard 27 features of the contract. It is a standardized contract with standard underlyinginstrument, a standard quantity and quality of the underlying instrument that can be delivered, (orwhich can be used for reference purposes in settlement) and a standard timing of such settlement.A futures contract may be offset prior to maturity by entering into an equal and oppositetransaction. More than 99% of futures transactions are offset this way. The standardized items ina futures contract are:

Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and minimum price change Location of settlement
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Futures Terminology

Spot pr ice:The price at which an asset trades in the spot market. Futur es price: The price at which the futures contract trades in the futures market. Contr act cycle:The period over which a contract trades. The index futures contracts on

the NSE have one- month, two-months and three months expiry cycles which expire onthe last Thursday of the month. Thus a January expiration contract expires on the lastThursday 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 havinga three- month expiry is introduced for trading.

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

Contr act size: The amount of asset that has to be delivered under one contract. Alsocalled as lot size.

Basis: In the context of financial futures, basis can be defined as the futures price minusthe spot price. There will be a different basis for each delivery month for each contract. In

a normal market, basis will be positive. This reflects that futures prices normally exceedspot prices.

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

I nitial margin: The amount that must be deposited in the margin account at the time afutures contract is first entered into is known as initial margin.


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

Maintenance margin :This is somewhat lower than the initial margin. This is set toensure that the balance in the margin account never becomes negative. If the balance inthe margin account falls below the maintenance margin, the investor receives a margincall and is expected to top up the margin account to the initial margin level before tradingcommences on the next day.


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H istory of Options

It is not known when the first option contract traded; however, similar contracts can be tracedback as far as the Romans and the Phoenicians, who used them in shipping, and ancient Greece,where a mathematician and philosopher named Thales used them to secure a low price for olivepresses in advance of the harvest. They were also used in the tulip trading craze in Holland in the1600s.

Options appeared in America roughly the same time as stocks. At first they were not traded on anexchange; trades were done privately between buyers and sellers. Growth in options tradingremained slow for the next few decades, mostly because trading by phone without being able to

determine the real market for a contract made them illiquid and cumbersome to trade.

I ntroduction to Options

In this section, we look at the next derivative product to be traded on the NSE, namely options.Options are fundamentally different from forward and futures contracts. An option gives theHolder of the option the right to do something. The holder does not have to exercise this right.In contrast, in a forward or futures contract, the two parties have committed themselves toDoing something. Whereas it costs nothing (except margin requirements) to enter into a futuresContract, the purchase of an option requires an up-front payment.
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Options Terminology

I ndex options: These options have the index as the underlying. Some options areEuropean while others are American. Like index futures contracts, index optionsContracts are also cash settled.

Stock options: Stock options are options on individual stoc ks. Options currently trade onover 500 stocks in the United States. A contract gives the holder the right to buy or sellshares at the specified price.

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

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

There are two basic types of options, call options and put options:

Call option:A call option gives the holder the right but not the obligation toBuy an asset by a certain date for a certain price.

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

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

Expi ration date: The date specified in the options contract is known as the expirationdate, the exercise date, the strike date or the maturity.

Stri ke pri ce: The price specified in the options contract is known as the strike price orthe exercise price.


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

European options: European options are options that can be exercised only on theexpiration date itself. European options are easier to analyze than American options andproperties of an American option are frequently deduced from those of its Europeancounterpart.

I n-the-money option:An in-the-money (ITM) option is an option that would lead to apositive cash flow to the holder if it were exercised immediately. A call option on theindex is said to be in-the-money when the current index stands at a level higher than thestrike price (i.e. spot price > strike price). If the index is much higher than the strikeprice, the call is said to be deep ITM. In the case of a put, the put is ITM if the index isbelow the strike price.

At- the-money option: An at-the-money (ATM) option is an option that would lead tozero cash flow if it were exercised immediately. An option on the index is at-the-moneywhen the current index equals the strike price(i.e. spot price = strike price).

Out-of -the-money option:An out-of-the-money (OTM) option is an option that wouldlead to a negative cash flow if it were exercised immediately. A call option on the indexis out-of-the-money when the current index stands at a level which is less than the strikeprice (i.e. spot price < strike price). If the index is much lower than the strike price, the

Call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strikeprice.

Time value of an option:The time value of an option is the difference between itspremium and its intrinsic value. Both calls and puts have time value. An option that is

OTM or ATM has only time value. Usually, the maximum time value exists when theoption is ATM. The longer the time to expiration, the greater is an option's time value, allelse equal. At expiration, an option should have no time value.


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Hedging


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What I s Hedging?

The best way to understand hedging is to think of it as insurance. When people decide to hedge,

they are insuring themselves against a negative event. This doesn't prevent a negative event from

happening, but if it does happen and you're properly hedged, the impact of the event is reduced.

So, hedging occurs almost everywhere, and we see it every day. For example, if you buy house

insurance, you are hedging yourself against fires, break-ins or other unforeseen disasters.

Portfolio managers, individual investors and corporations use hedging techniques to reduce their

exposure to various risks. In financial markets, however, hedging becomes more complicated

than simply paying an insurance company a fee every year. Hedging against investment riskmeans strategically using instruments in the market to offset the risk of any adverse price

movements. In other words, investors hedge one investment by making another.

Technically, to hedge you would invest in two securities with negativecorrelations. Of course,

nothing in this world is free, so you still have to pay for this type of insurance in one form or

another.

Although some of us may fantasize about a world where profit potentials are limitless but also

risk free, hedging can't help us escape the hard reality of therisk-return tradeoff. A reduction in

risk will always mean a reduction in potential profits. So, hedging, for the most part, is a

technique not by which you will make money but by which you can reduce potential loss. If the

investment you are hedging against makes money, you will have typically reduced the profit that

you could have made, and if the investment loses money, your hedge, if successful, will reduce

that loss.
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How Do I nvestors Hedge?

Hedging techniques generally involve the use of complicated financial instruments known as

derivatives, the two most common of which areoptionsandfutures. We're not going to get into

the nitty-gritty of describing how these instruments work, but for now just keep in mind that with

these instruments you can develop trading strategies where a loss in one investment is offset by a

gain in a derivative difficult to achieve in practice.

What H edging M eans to You

The Downside

Every hedge has a cost, so before you decide to use hedging, you must ask yourself if the

benefits received from it justify the expense. Remember, the goal of hedging isn't to make moneybut to protect from losses. The cost of the hedge - whether it is the cost of an option or lost

profits from being on the wrong side of a futures contract - cannot be avoided. This is the price

you have to pay to avoid uncertainty.

We've been comparing hedging versus insurance, but we should emphasize that insurance is far

more precise than hedging. With insurance, you are completely compensated for your loss

(usually minus a deductible). Hedging a portfolio isn't a perfect science and things can go wrong.

Although risk managers are always aiming for the perfect hedge, it is

The majority of investors will never trade a derivative contract in their life. In fact mostbuy-and-

holdinvestors ignore short-term fluctuation altogether. For these investors there is little point in

engaging in hedging because they let their investments grow with the overall market.
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So why learn about hedging?

Even if you never hedge for your own portfolio you should understand how it works because

many big companies and investment funds will hedge in some form. Oil companies, for example,

might hedge against the price of oil while an international mutual fund might hedge against

fluctuations in foreign exchange rates. An understanding of hedging will help you to comprehend

and analyze these investments.


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Options strategies: long call

Purchasing calls has remained the most popular strategy with investors since listed options werefirst introduced. Before moving into more complex bullish and bearish strategies, an investorshould thoroughly understand the fundamentals about buying and holding call options.

Market Opinion?

Bullish to Very Bullish

When to Use?

This strategy appeals to an investor who is generally more interested in the dollar amount of hisinitial investment and the leveraged financial reward that long calls can offer. The primarymotivation of this investor is to realize financial reward from an increase in price of theunderlying security. Experience and precision are key to selecting the right option (expirationand/or strike price) for the most profitable result. In general, the more out-of-the-money the callis the more bullish the strategy, as bigger increases in the underlying stock price are required forthe option to reach the break-even point.


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Options Strategies: Long Put

A long put can be an ideal tool for an investor who wishes to participate profitably from a

downward price move in the underlying stock. Before moving into more complex bearishstrategies, an investor should thoroughly understand the fundamentals about buying and holdingput options.

Market Opinion?

Bearish

When to Use?

Purchasing puts without owning shares of the underlying stock is a purely directional strategy

used for bearish speculation. The primary motivation of this investor is to realize financialreward from a decrease in price of the underlying security. This investor is generally moreinterested in the dollar amount of his initial investment and the leveraged financial reward thatlong puts can offer than in the number of contracts purchased.

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


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Options Strategies: Marr ied Put

An investor purchasing a put while at the same time purchasing an equivalent number of sharesof the underlying stock is establishing a "married put" position - a hedging strategy with a namefrom an old IRS ruling.

Market Opinion?

Bullish to Very Bullish

When to Use?

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


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Options Strategies: Protective Put

An investor who purchases a put option while holding shares of the underlying stock from a

previous purchase is employing a "protective put."

Market Opinion?

Bullish on the Underlying Stock

When to Use?

The investor employing the protective put strategy owns shares of underlying stock from a

previous purchase, and generally has unrealized profits accrued from an increase in value ofthose shares. He might have concerns about unknown, downside market risks in the near termand wants some protection for the gains in share value. Purchasing puts while holding shares ofunderlying stock is a directional strategy, but a bullish one.


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Options Strategies: Covered Call

The covered call is a strategy in which an investor writes a call option contract while at the same

time owning an equivalent number of shares of the underlying stock. If this stock is purchasedsimultaneously with writing the call contract, the strategy is commonly referred to as a "buy-write." If the shares are already held from a previous purchase, it is commonly referred to an"overwrite." In either case, the stock is generally held in the same brokerage account from whichthe investor writes the call, and fully collateralizes, or "covers," the obligation conveyed bywriting a call option contract. This strategy is the most basic and most widely used strategycombining the flexibility of listed options with stock ownership.

Market Opinion?

Neutral to Bullish on the Underlying Stock

When to Use?

Though the covered call can be utilized in any market condition, it is most often employed whenthe investor, while bullish on the underlying stock, feels that its market value will experiencelittle range over the lifetime of the call contract. The investor desires to either generate additionalincome (over dividends) from shares of the underlying stock, and/or provide a limited amount of

protection against a decline in underlying stock value.


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Options Strategies: Cash Secured Put

According to the terms of a put contract, a put writer is obligated to purchase an equivalentnumber of underlying shares at the put's strike price if assigned an exercise notice on the writtencontract. Many investors write puts because they are willing to be assigned and acquire shares ofthe underlying stock in exchange for the premium received from the put's sale. For thisdiscussion, a put writer's position will be considered as "cash-secured" if he has on deposit withhis brokerage firm a cash amount (or equivalent) sufficient to cover such a purchase.

Market Opinion?

Neutral to Slightly Bullish


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When to Use?

There are two key motivations for employing this strategy: either as an attempt to purchaseunderlying shares below current market price, or to collect and keep premium from the sale ofputs which expire out-of-the-money and with no value. An investor should write cash securedput only when he would be comfortable owning underlying shares, because assignment is alwayspossible at any time before the put expires. In addition, he should be satisfied that the net cost forthe shares will be at a satisfactory entry point if he is assigned an exercise. The number of putcontracts written should correspond to the number of shares the investor is comfortable andfinancially capable of purchasing. While assignment may not be the objective at times, it shouldnot be a financial burden. This strategy can become speculative when more puts are written thanthe equivalent number of shares desired to own.


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Options Strategies: Bul l Call Spread

Establishing a bull call spread involves the purchase of a call option on a particular underlyingstock, while simultaneously writing a call option on the same underlying stock with the sameexpiration month, at a higher strike price. Both the buy and the sell sides of this spread areopening transactions, and are always the same number of contracts. This spread is sometimesmore broadly categorized as a "vertical spread": a family of spreads involving options of thesame stock, same expiration month, but different strike prices. They can be created with either allcalls or all puts, and be bullish or bearish. The bull call spread, as any spread, can be executed asa"unit" in one single transaction, not as separate buy and sell transactions. For this bullishvertical spread, a bid and offer for the whole package can be requested through your brokerage

firm from an exchange where the options are listed and traded.

Market Opinion?

Moderately Bullish to Bullish


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Whento Use?

Moderately bul li sh

An investor often employs the bull call spread in moderately bullish market environments, andwants to capitalize on a modest advance in price of the underlying stock. If the investor's opinionis very bullish on a stock it will generally prove more profitable to make a simple call purchase.

Risk Reduction

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


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Options Strategies: Bear Put Spread

Establishing a bear put spread involves the purchase of a put option on a particular underlyingstock, while simultaneously writing a put option on the same underlying stock with the sameexpiration month, but with a lower strike price. Both the buy and the sell sides of this spread areopening transactions, and are always the same number of contracts. This spread is sometimesmore broadly categorized as a "vertical spread": a family of spreads involving options of thesame stock, same expiration month, but different strike prices. They can be created with either allcalls or all puts, and be bullish or bearish. The bear put spread, as any spread, can be executed as

a "package" in one single transaction, not as separate buy and sell transactions. For this bearishvertical spread, a bid and offer for the whole package can be requested through your brokeragefirm from an exchange where the options are listed and traded.

Market Opinion?

Moderately Bearish to Bearish

When to Use?

Moderately beari sh

An investor often employs the bear put spread in moderately bearish market environments, andwants to capitalize on a modest decrease in price of the underlying stock. If the investor's opinionis very bearish on a stock it will generally prove more profitable to make a simple put purchase.

Risk reduction

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


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Options Strategies: Col lar

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

Market Opinion?

Neutral, following a period of appreciation

When to Use?

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


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Options Strategies: Long Straddle

The long straddle is simply the simultaneous purchase of a long call and a long put on the sameunderlying security with both options having the same expiration and same strike price. Becausethe position includes both a long call and a long put, the investor in a straddle should have acomplete understanding of the risks and rewards associated with both long calls and long puts.

**Since the straddle involves two trades, a commission charge is likely for the purchase (and anysubsequent sale) of each position -- one commission for the call and one commission for the put.

Market Opinion?

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


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When to Use?

Purchasing only long calls or only long puts is primarily a directional strategy. The long straddle

however, consisting ofboth long calls and long puts is not a directional strategy, rather it is onewhere the investor feels large price swings are forthcoming but is unsure of the direction. Thisstrategy may prove beneficial when the investor feels large price movement, either up or down,is imminent but is uncertain of the direction.

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

at the strike price of the straddle until expiration.


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Options Strategies: Long Strangle

The long strangle is simply the simultaneous purchase of a long call anda long put on the sameunderlying security with both options having the same expiration but where the put strike price islower than the call strike price. Because the position includes both a long call and a long put, theinvestor using a long strangle should have a complete understanding of the risks and rewardsassociated with both long calls and long puts.

Market Opinion?

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


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When to Use?

Purchasing only long calls or only long puts is primarily a directional strategy. The long stranglehowever, consisting ofboth long calls and long puts is a not a directional strategy, rather onewhere the investor feels extremely large price swings are forthcoming but is unsure of thedirection. This strategy may prove beneficial when the investor feels large price movement,either up or down, is about to happen but uncertain of the direction.

An instance of when a strangle may be considered is when an earnings announcement isforthcoming. The investor feels the projected announcement will introduce large price

swings in the underlying. If the earnings announcement and future outlook is positive, this maypositively impact the price of the security. If the earning announcement and outlook is negative,or fails to impress investors, the stock could decline considerably. The risk is the stock remainsstable or between the strike price of the call and strike price of the put until expiration. Anotherrisk is that the stock's move does not produce a corresponding option price increase that isenough to cover the two premiums paid for the position. Declining implied volatility will alsonegatively impact this strategy.


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Payoff

&Pricing of

Futures and Options


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Payoff for futures

Futures contracts have linear payoffs. In simple words, it means that the losses as well as profitsfor the buyer and the seller of a futures contract are unlimited.

These linear payoffs are fascinating as they can be combined with options and the underlying togenerate various complex payoffs.

Payoff for buyer of futures: Long futures

The payoff for a person who buys a futures contract is similar to the payoff for a person whoholds an asset. He has a potentially unlimited upside as well as a potentially unlimited downside.

Take the case of a speculator who buys a two-month Nifty index futures contract when the Niftystands at 1220. The underlying asset in this case is the Nifty portfolio. When the index moves up,the long futures position starts making profits, and when the index moves down it starts makinglosses. Figure 5.1 shows the payoff diagram for the buyer of a futures contract.

Payoff for seller of futures: Short futures

The payoff for a person who sells a futures contract is similar to the payoff for a person whoshorts an asset. He has a potentially unlimited upside as well as a potentially unlimited downside.Take the case of a speculator who sells a two-month Nifty index futures contract when the Niftystands at 1220. The underlying asset in this case is the Nifty portfolio. When the index moves

down, the short futures position starts making profits, and when the index moves up, it startsmaking losses. Figure 5.2 shows the payoff diagram for the seller of a future Contract


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Figure 5.1 Payoff for a buyer of Nifty futures

The figure shows the profits/losses for a long futures position. The investor bought futures when

the index was at 1220. If the index goes up, his futures position starts making profit. If the index

falls, his futures position starts showing losses.

Profit

1220

0

Nifty

Figure 5.2 Payoff for a seller of Nifty futures

The figure shows the profits/losses for a short futures position. The investor sold futures whenthe index was at 1220. If the index goes down, his futures position starts making profit. If the

index rises, his futures position starts showing losses.

Profit

1220

0 Nifty Loss


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5.2 Options payoffs

The optionality characteristic of options results in a non-linear payoff for options. In simple

words, it means that the losses for the buyer of an option are limited, however the profits are

potentially unlimited. For a writer, the payoff is exactly the opposite. His profits are limited to

the option premium; however his losses are potentially unlimited.

These non-linear payoffs are fascinating as they lend themselves to be used to generate various

payoffs by using combinations of options and the underlying. We look here at the six basic

payoffs.

5.2.1 Payoff profile of buyer of asset: Long asset

In this basic position, an investor buys the underlying asset, Nifty for instance, for 1220, and

sells it at a future date at an unknown price,S4 it is purchased, the investor is said to be long the

asset. Figure 5.3 shows the payoff for a long position on the Nifty. 1

Figure 5.3 Payoff for investor who went Long Nifty at 1220

The figure shows the profits/losses from a long position on the index. The investor bought the

index at 1220. If the index goes up, he profits. If the index falls he looses.

Profit

+60

0 1160 1220 1280

Loss


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5.2.2 Payoff profile for seller of asset: Short asset

In this basic position, an investor shorts the underlying asset, Nifty for instance, for 1220, and

buys it back at a future date at an unknown price S4 Once it is sold, the investor is said to be

short the asset. Figure 5.4 shows the payoff for a short position on the Nifty.

Figure 5.4 Payoff for investor who went Short Nifty at 1220

The figure shows the profits/losses from a short position on the index. The investor sold the

index at 1220. If the index falls, he profits. If the index rises, he looses.

Profit

+60

0 1160 1220 1280

Nifty

-60 Loss

5.2.3 Payoff profile for buyer of call options: Long call

A call option gives the buyer the right to buy the underlying asset at the strike price specified in

the option. The profit/loss that the buyer makes on the option depends on the spot price of the

underlying. If upon expiration, the spot price exceeds the strike price, he makes a profit. Higher

the spot price, more is the profit he makes. If the spot price of the underlying is less than the

strike price, he lets his option expire un-exercised. His loss in this case is the premium he paid


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for buying the option. Figure 5.5 gives the payoff for the buyer of a three month call option

(often referred to as long call) with a strike of 1250 bought at a premium of 86.60.

5.2.4 Payoff profile for writer of call options: Short call

A call option gives the buyer the right to buy the underlying asset at the strike price specified in

the option. For selling the option, the writer of the option charges a premium. The profit/loss that

the buyer makes on the option depends on the spot price of the underlying. Whatever is the

buyers profit is the sellers loss. If upon expiration, the spot price exceeds the strike price, the

buyer will exercise the option on the writer. Hence as the spot price increases the writer of the

option starts making losses. Higher the spot price, more is the loss he makes. If upon expiration

the spot price of the underlying is less than the strike price, the buyer lets his option expire un-

exercised and the writer gets to keep the premium. Figure 5.6 gives the payoff for the writer of a

three month call option (often referred to as short call) with a strike of 1250 sold at a premium of

86.60.

Figure 5.5 Payoff for buyer of call option

The figure shows the profits/losses for the buyer of a three-month Nifty 1250 call option. As can

be seen, as the spot Nifty rises, the call option is in-the-money. If upon expiration, Nifty closes

above the strike of 1250, the buyer would exercise his option and profit to the extent of thedifference between the Nifty-close and the strike price. The profits possible on this option are

potentially unlimited. However if Nifty falls below the strike of 1250, he lets the option expire.

His losses are limited to the extent of the premium he paid for buying the option.

Profit

1250

Nifty


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0 Loss

Figure 5.6 Payoff for writer of call option

The figure shows the profits/losses for the seller of a three-month Nifty 1250 call option. As the

spot Nifty rises, the call option is in-the-money and the writer starts making losses. If upon

expiration, Nifty closes above the strike of 1250, the buyer would exercise his option on the

writer who would suffer a loss to the extent of the difference between the Nifty-close and the

strike price. The loss that can be incurred by the writer of the option is potentially unlimited,

whereas the maximum profit is limited to the extent of the up-front option premium of Rs.86.60

charged by him.

Profit

86.60

1250

0 Nifty1 Loss

5.2.5 Payoff profile for buyer of put options: Long put

A put option gives the buyer the right to sell the underlying asset at the strike price specified in

the option. The profit/loss that the buyer makes on the option depends on the spot price of the

underlying. If upon expiration, the spot price is below the strike price, he makes a profit. Lower

the spot price, more is the profit he makes. If the spot price of the underlying is higher than the

strike price, he lets his option expire un-exercised. His loss in this case is the premium he paid

for buying the option. Figure 5.7 gives the payoff for the buyer of a three month put option (often

referred to as long put) with a strike of 1250 bought at a premium of 61.70.


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Figure 5.7 Payoff for buyer of put option

The figure shows the profits/losses for the buyer of a three-month Nifty 1250 put option. As can

be seen, as the spot Nifty falls, the put option is in-the-money. If upon expiration, Nifty closes

below the strike of 1250, the buyer would exercise his option and profit to the extent of the

difference between the strike price and Nifty-close. The profits possible on this option can be as

high as the strike price. However if Nifty rises above the strike of 1250, he lets the option expire.

His losses are limited to the extent of the premium he paid for buying the option.

Profit

1250

0 Nifty

61.70

Loss

Payoff profile for writer of put options: Short put

A put option gives the buyer the right to sell the underlying asset at the strike price specified in

the option. For selling the option, the writer of the option charges a premium. The profit/loss thatthe buyer makes on the option depends on the spot price of the underlying. Whatever is the

buyers profit is the sellers loss. If upon expiration, the spot price happens to be below the strike

price, the buyer will exercise the option on the writer. If upon expiration the spot price of the

underlying is more than the strike price, the buyer lets his option expire un-exercised and the


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writer gets to keep the premium. Figure 5.8 gives the payoff for the writer of a three-month put

option (often referred to as short put) with a strike of 1250 sold at a premium of 61.70.

Figure 5.8 Payoff for writer of put option

The figure shows the profits/losses for the seller of a three-month Nifty 1250 put option. As the

spot Nifty falls, the put option is in-the-money and the writer starts making losses. If upon

expiration, Nifty closes below the strike of 1250, the buyer would exercise his option on the

writer who would suffer a loss to the extent of the difference between the strike price and Nifty-

close. The loss that can be incurred by the writer of the option is a maximum extent of the strike

price(Since the worst that can happen is that the asset price can fall to zero) whereas the

maximum profit is limited to the extent of the up-front option premium of Rs.61.70 charged by

him.

Profit

61.70

1250

0 Nifty

Loss


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SUMMARY:

Derivatives market is on innovation to cash market, approximately its daily turnover reaches to

equal stage of cash market.

In the cash market. The profit/ loss of the investor depend on the market price of the underlying

asset. The investor may incur huge profit or he may incur huge loss but in derivative segment the

investor enjoys huge profit with limited down side. In cash market the investor as to pay the total

money. But in derivatives the investor as to pay premium or margins which are some

percentage of total money.

Derivatives are mostly used for hedging purpose. In derivatives segment the profit/loss of the

option holder/option writer is purely depended on the fluctuations of the under lying assets


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Conclusion

Derivatives are extremely important and have a big impact on other financial market and the

economy. The project is designed to upgrade investors knowledge with the basics of how to

make investment decisions in futures & options with reference to bear market. Analyze the

fundamental, technical and other factors for dealing in futures & options. Hedging is for

minimizing risk not for maximizing the profit. For many investors, options are useful as tools of

risk management.

In cash market the profit/loss of the investor may be limited, but in the Derivative market. The

investor can enjoy unlimited profits and minimize the losses incurred.

In derivatives market the investors enjoys the privilege of paying less amount in case of options.Derivatives are mostly used for hedging purpose.


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Bibliography:-

1)Derivatives Market (Basic) Module:--NCFM

2)Economic Times

3)Business Standard

4) www.Motilaloswal.com

5) www.nseindia.com

6) www.moneycontrol.com

7) www.derivativesindia.com

8)A Beginner's Guide To Hedging
http://www.motilaloswal.com/http://www.motilaloswal.com/http://www.nseindia.com/http://www.nseindia.com/http://www.moneycontrol.com/http://www.moneycontrol.com/http://www.investopedia.com/articles/basics/03/080103.asphttp://www.investopedia.com/articles/basics/03/080103.asphttp://www.moneycontrol.com/http://www.nseindia.com/http://www.motilaloswal.com/


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