sneh summer report (Repaired)

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Summer Internship Program me 2010 Page 1

A

PROJECT REPORT

ON

Derivative Market & Gold ETF

BY

Sneh Bhayani

Orbit Financial Services


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CERTIFICATE


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Acknowledgment

It gives me deep satisfaction and immense pleasure to present this report on

Derivative Markets & Gold ETF undertaken as a summer trainee with

Shenzen INVT Electric Co., Ltd.I would like to take this opportunityto thank myCompany guide Mr. Harshad Shah Branch Manager, Orbit Financial Services.

who has taken all the time and effortto guide me throughthis project.

I would also like to thank Director Dr. Mrinalini Kohojkar, Prof. Akshay

Damani, my Placement Coordinator, Ms. Harshita Kumar and Ms. Nitya Datar

at Thakur Institute of Management Studies and Research for giving me an

opportunityto work with Orbit Finance Services

I would like to thank the entire team of Orbit Financial Services, who has come

forward withhelping hands whenever any assistance has been sought. The Data

Researchhas been primary and thus, I would like to thank all the respondents who

have taken time out to answer my phone calls & e-mails during the summer

internship.

Withoutthe support and guidance of all the people mentioned above it would have

been very difficult for me to consummate this project.


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Executive Summary

The project is undertaken to study and to understand the working ofthe

Derivatives Market in India. In India how the derivative markethas evolved and

developed overthe period ofyears.

The project report contains the basic information aboutthe various derivative

instruments in the derivative marketto have a clear understanding ofthis market.

The report also helps us to understand some ofthe important option strategies with

the help ofthe payoff diagrams.

This study on the derivatives market gave me an opportunityto know in detail

aboutthe derivatives market and its contribution in the secondary market.

This report also contains a small study on GOLD ETF and physical gold.


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y About Orbit Finance

We aim to become class of our own in terms of investments, client

services and business ethics. We will always get in the best interest of our

investors and create wealth forthem & also opportunities and reward for

our employees.

We are committed to assisting you in achieving your unique financial

goals, while freeing yourtime, and your life, ofthe day-to-day worries of

managing money and making sure thatyour money works foryou as hard

as you work for it.

THE CUSTOMER IS THE HEART OF OUR BUSINESSWe aim to build a relationship with each of our customer by understanding

their needs and goals. We advise and plan their investments in such a

mannerthatthe customer ultimate goal is achieved.

A COMMITMENT TO TECHNOLOGYWe at orbit believe in giving value added services to our customer by

having latesttechnology in place so that investors has better control of

his/her investments.

OUR PEOPLE ARE OUR FUTUREOur philosophy is based on seeking opportunities for growth and investing

in them. This applies to our people as much as our investment process.

People invest because theythink about future. They know there are

challenges ahead. This is the thoughtthat drives young person putting

money aside for retirement.

YOU ARE INVITED TO JOIN OUR "CLIENT FAMILY"."At OFS, we welcome you, not only as a client, but also on a personal

level. Our business practice is unique because we treatyou as a person, a

friend, and a member of our "Family."From scheduled calls and meetings

to regular updates, workshops, and social events, we stay in touchto let

you know what's happening, and to be sure your needs are known andaddressed. We strive to go beyond just providing you with financial

advisory service.

VISIONTo become a Leader by creating Wealth forthe people globally by

providing Customized Financial Solutions.


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MISSIONTo help people to achive their financial goals.

To provide Innovative services by leveraging technology

To be honest, transparent and ethical in ourtransactions.

To provide knowledge, skills and training to employees.

To constantly improve ourselves, ourteams and our services.

QUALITY POLICY

y 1. A commitmentto strive relentlessly, to constantly improve

ourselves, ourteams, our services so as to become the best.

y A commitmentto set standards in our business and transactions and

be exemplar forthe industry and our own teams.y A commitmentto be ethical, sincere and open in our dealings.

QUALITY OBJECTIVESy Design and develop in-house processes to ensure high quality and

timely services to clients.

y Provide adequate knowledge, skills and training to employees to

meetthe requirements of clients.

y Use superiortechnology for providing innovative services to meet

the changing needs of clients.

y Establish a business partner relationship with agents and vendors to

keep clients commitments.

y Continue to uphold the values ofhonesty and integrity and strive to

establish unparalleled standards in business ethics.

y Strive to be reliable source of value-added financial products and

services and constantly guide the clients in making judicious choice

ofthe same.

PHILOSOPHYTo endeavorto create an association and organization incorporating the

values of integrity and dedication, one which progressively evolves with

time to meetthe challenges of future by creating wealth, by growing

wealth and preserving wealth for all with whom we are associated.


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CORE VALUES

Strong values have been a part of ORBIT since we started. We believe in

diversity, customer satisfaction, employee involvement, innovations,

integrity anfteam work.

We strive for constant improvement in every area of our business and we

worktirelesslyto ensure maintaining ofhighest ethical standards. A

promise made is promise keep.

STRENGTHSGood Infrastructure (Office at prime location in western suburb)

All Financial Products under one roof.

System and Procedure in place with latesttechnology.

Experienced Manpower.

Client Relationship.Brand name.

Training to employees.


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Table of Contents

Sr. No. Particulars Page No.

Acknowledgement 4

Executive Summary 5

About orbit Finance 6

1. Derivatives10

2.

Options 23

3.

Trading in options 25

4. y Option Spread 30

5. y Physical Gold v/s Gold ETF 32

6. Appendix 36

7. References 36


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1. DERIVATIVES IN INDIA

1.1. INTRODUCTION TO DERIVATIVES/RISE OF DERIVATIVES

The emergence of the market for derivative products, most notably forwards, futures and

options, can be traced back to the willingness of risk-averse economic agents to guard

themselves against uncertainties arising out of fluctuations in asset prices. By their very

nature, the financial markets are marked by a veryhigh degree of volatility. Through the

use of derivative products, it is possible to partially or fullytransfer price risks by locking-

in asset prices. As instruments of risk management, these generally do not influence the

fluctuations in the underlying asset prices. However, by locking-in asset prices, derivativeproducts minimize the impact of fluctuations in asset prices on the profitability and cash

flow situation of risk-averse investors.

The global economic orderthat emerged after World WarII was a system where many less

developed countries administered prices and centrally allocated resources. Even the

developed economies operated underthe Bretton Woods system of fixed exchange rates.

The system of fixed prices came under stress from the 1970s onwards. High inflation and

unemployment rates made interest rates more volatile. Once a system vanished in 1971,whichhad forced countries to adjusttheir inflation rates, interest rates and othertools of

economic policy in orderto maintain a fixed relationship between their currency and the

gold/dollar price, governments were free to pursue divergent monetary policies. The result

has a permanent change in the financial environment. Developed economies experienced

periods of both rapid price increases (inflation) and price decreases (deflation). Uncertainty

and volatility in relation to prices was followed by similar uncertainty and volatility in

foreign exchange rates, interest rates and commodity prices. Price fluctuations make ithard

for businesses to estimate their future production costs and revenues. Derivative securitiesprovide them a valuable set oftools for managing this risk

As has already been indicated, the risk associated with a financial environment which lacks

stability and is characterized by change and flux has created a demand -- a demand to


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whichthe capital markets have responded -- for financial instruments to protect againstthat

risk. These instruments are usually called derivative instruments and a derivative financial

instrument can be defined as simply an aggregate or "bundle" of contractually created

rights and obligations, the effect of which is to create a transfer or exchange of specified

cash-flows at defined future points in time. The quantum ofthese cash-flows are

determined by reference to, or derived from (hence the word "derivative"), underlying cash

or physical markets (e.g. foreign exchange, currency, securities, commodities) or from

particular financial indices (such as one ofthe benchmark interest rates, the London inter-

bank offered rate or Libor).


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1.2. Definition and Uses of Derivatives

A derivative security is a financial contract whose value is derived from the value of

something else, such as a stock price, a commodity price, an exchange rate, an interest rate,

or even an index of prices. These are called underlying asset .Derivatives may be traded for

a variety of reasons. A derivative enables a traderto hedge some preexisting risk bytaking

positions in derivatives markets that offset potential losses in the underlying or spot

market. For example, wheat farmers may wishto sell theirharvest at a future date to

eliminate the risk of a change in prices bythat date. The price ofthis derivative is driven

bythe spot price of wheat which is the underlying. In the Indian contextthe Securities

Contracts (Regulation) Act, 1956 (SC(R) A) defines equity derivative to include

1. A security derived from a debt instrument, share, loan whether secured or unsecured,

risk instrument or contract for differences or any other form of security.

2. A contract, which derives its value from the prices, or index of prices, of underlying

securities.

The derivatives are securities underthe SC(R) A and hence the trading of derivatives is

governed bythe regulatory framework underthe SC(R) A.1

In India, most derivatives users describe themselves as hedgers (FitchRatings, 2004) and

Indian laws generally require that derivatives be used forhedging purposes only. Another

motive for derivatives trading is speculation (i.e. taking positions to profit from anticipated

price movements). In practice, it may be difficultto distinguish whether a particulartrade

was for hedging or speculation, and active markets require the participation of both

hedgers and speculators.


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3. A third type oftrader, called arbitrageurs, profit from discrepancies in the relationship of

spot and derivatives prices, and thereby help to keep markets efficient. Jogani and

Fernandes (2003) describe Indias long history in arbitrage trading, with line operators and

traders arbitraging prices between exchanges located in different cities, and between two

exchanges in the same city. Their study of Indian equity derivatives markets in 2002

indicates that markets were


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1.3. THE SCENARIO IN INDIA

After deregulation, freeing ofthe exchange rate and removal of price and trade controls are

measures that are increasing the volatility of prices of various goods and services in India

to producers and consumers alike. Gyrations of stock market prices (and market-

determined interest and exchange rates) also create instability in portfolio values for

mutual funds and unittrusts. Hedging through derivatives can mitigate these risks.

The 1960s marked a period of great decline in futures trading in India. Market after

market was closed, normally because commodity price rises were attributed to speculation

on these markets.

There are signs thatthe late 1990s may be marked by exactlythe opposite trend-a large-

scale revival of futures markets in India.

The trend is not confined to the commodity markets. RBI recommended major

liberalisation ofthe forward exchange market and had urged the setting up of rupee-based

derivatives in financial instruments.

In a momentous and far reaching decision, SEBI gave the go-ahead for stock index futures

in May1998, ushering a new era in Indian financial markets.

Derivative trading started withthe introduction ofIndex (Sensex) Futures atthe NSE and

the BSE in June 2000. The exchange have the Futures and Options Trading System which

provides a fully automated trading environment. A committee was setup underthe

chairmanship of Prof. J.R. Varma along with others to provide the guidelines for derivative

trading in India. The first ofthe 5 contracts ofthe June series was done on June 9, 2000

between M/s Kaji & Maulik Securities Pvt. Ltd. and M/s Emkay Share & StockBrokers

Ltd. atthe rate of 4755.


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This marked the beginning of exchange traded financial derivatives trading in India. We

have a strong dollar-rupee forward market with contracts being traded for one to six

months. As of now there is very little trading in futures and options in India. Trades are

settled on a weekly basis due to low volumes and volatilities.


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1.4 Need for Derivatives in India

Derivatives came into being primarily forthe reason ofthe need to eliminate price

risk.

Risk is a characteristic feature of all commodity and capital markets. Prices of all

commodities-whether agricultural like wheat, cotton, rice, coffee or tea, or non

agricultural like silver, gold, etc. are subject to fluctuation over time in keeping

with prevailing demand and supply conditions. Producers or possessors of these

commodities obviously cannot be sure of the prices that their produce or

possession may fetch when theyhave to sell them, in the same way as the buyers

and the processors are not sure whatthey would have to pay fortheir buy.

Similarly, prices of shares and debentures or bonds and other securities are also

subjectto continuous change. Owners of shares of a company face the riskthatthe

market price ofthat share may fall below the price at whichthey were purchased.

In the same way, the foreign exchange rates are also subjectto continuous change.

Thus, an importer of a certain piece of machinery is not sure of the amount he

would have to pay in rupee terms when the payments become due.

While examples where risk is seen to exist, can be multiple, it may be observed

that parties involved in all such cases may see the benefits of, and are likely to

desire, having some contract from which forward prices may be fixed and the price

risk facing them is eliminated and therefore to reduce the risk, derivatives was

introduced.


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1.5 Milestones in the development of Indian derivative market

Year Developments

November18,

1996

L.C. Gupta Committee set up to draft a policy framework

for introducing derivatives

May11, 1998 L.C. Gupta committee submits its report on the policy

framework.

May 25, 2000 SEBI allows exchanges to trade in index futures

June 12, 2000 Trading on Nifty futures commences on the NSE

June 4, 2001 Trading forNifty options commences o n the NSE

July 2, 2001 Trading on Stock options commences on the NSE

November9,

2001

Trading on Stock futures commences on the NSE

August 29, 2008 Currency derivatives trading commences on the NSE

August 31, 2009 Interest rate derivatives trading commences on the NSE


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1.6. ECONOMIC FUNCTION OF THE DERIVATIVEMARKET

Inspite ofthe fear and criticism with whichthe derivative markets are commonly looked at,

these markets perform a number of economic functions.

1. Prices in an organized derivatives market reflectthe perception of market participants

aboutthe future and lead the prices of underlying to the perceived future level. The prices

of derivatives converge withthe prices ofthe underlying atthe expiration ofthe derivative

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

2. The derivatives markethelps to transfer risks from those who have them but may not

like them to those who have an appetite forthem.

3. Derivatives, due to their inherent nature, are linked to the underlying cas markets. With

the introduction of derivatives, the underlying market witnesses highertrading volumes

because of participation by more players who would not otherwise participate for lack of

an arrangementto transfer risk.

4. Speculative trades shiftto a more controlled environment of derivatives market. In the

absence of an organized derivatives market, speculators trade in the underlying cash

markets. Margining, monitoring and surveillance ofthe activities of various participants

become extremely difficult in these kind of mixed markets.


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1.7 DERIVATIVE PRODUCTS

Derivative contracts have several variants. The most common variants are forwards,

futures, options and swaps. We take a brief look at various derivatives contracts thathave

come to be used.

A.Forwards:A forward contract is a customized contract between two entities, where settlementtakes

place on a specific date in the future attoday's pre- agreed price.

B.

Futures:

A futures contract is an agreement between two parties to buy or sell an asset at a certain

time in the future at a certain price. Futures contracts are special types of forward contracts

in the sense thatthe former are standardize exchange- traded contracts.

C.Options:Options are oftwo types - calls and puts. Calls give the buyerthe right but notthe

obligation to buy a given quantity ofthe underlying asset, at a given price on or before a

given future date. Puts give the buyerthe right, but notthe obligation to sell a given

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

D.Warrants:Options generallyhave lives of up to one yea , the majority of options traded on options

exchanges having a maximum maturity of nine months. Longer- dated options are calledwarrants and are generallytraded over-the-counter.


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E.LEAPS:The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options

having a maturity of up to three years.

F. Baskets:Basket options are options on portfolios of underlying assets. The underlying asset is

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

options.

G. Swaps:Swaps are private agreements between two parties to exchange cash flows in the future

according to a prearranged formula. They can be regarded as portfolios of forward

contracts. The two commonly used swaps are:

Interest rate swaps:

These entail swapping onlythe interest related cash flows between the parties in the same

currency.

Currency swaps:

These entail swapping both principal and interest between the parties, withthe cash flows

in one direction being in a different currencythan those in the opposite direction.

H. Swaptions:

Swaptions are options to buy or sell a swap that will become operative atthe expiry ofthe

options. Thus a swaption is an option on a forward swap. Ratherthan have calls and puts,

the swaptions markethas receiver swaptions and payer swaptions. A receiver swaption is

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

receive floating.


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1.8 Players in derivatives market

When managed properly, derivative products can be efficient, powerful financial tools that

enhance stability of business operations.

Hedgers

Hedging is defined as reducing exposure to risk of loss resulting from fluctuations in

exchange rates, commodity prices, interest rates etc.Hedgers participate in the derivatives

marketto lockthe prices at whichthey will be able to do the transaction in the future. Thus

they are trying to avoid the price risk.

Arbitrators

Arbitrage is possible when one ofthree conditions is met

yThe same asset does nottrade at same price on all markets

yTwo assets with identical cash flows do nottrade atthe same price

yAn asset with a known price in future does nottrade today at its future price

discounted at risk free interest rate.

Arbitrators watchthe spot and futures markets and wheneverthey spot a mismatch in

the prices ofthe two markets they enterto getthe extra profit in a risk-free transaction.

Speculators

Speculators participate in the futures marketto take up the price risk, which is avoided by

the hedgers. Speculation is more commonly used byhedge funds ortraders who aim to

generate profits with only marginal investments, essentially placing a bet on the movement

of an asset. Leverage is the use of various financial instruments or borrowed capital, such

as margin, to increase the potential return of an investment. Leverage can be created

through options, futures, margin and other financial instruments. For example, sayyouhave Rs. 5,000to invest. This amount could be invested in 10 shares of ABC Limited, but

to increase leverage, you could invest Rs 5,000 in five options contracts. You would then

control 500 shares instead of just10.


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As we saw various products of derivatives market let me throw a light mainly on

OPTIONS covering the definition, terminologies used in options, and different options

strategies.


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2.OPTIONS

2.1INTRODUCTION TO OPTIONS:An option is a contract written by a sellerthat conveys to the buyerthe right, but notthe

obligation to buy in the case of a call option orto sell in the case of a put option a

particular asset, at a particular price say at Strike price in future. In return for granting the

option, the seller collects the premium from the buyer. Exchange traded options form an

important class of options whichhave standardized contract features and trade on public

exchanges, facilitating trading among large number of investors. They provide settlement

guarantee by the Clearing Corporationthereby reducing counterparty risk. Options can

be used forhedging, taking a view on the future direction ofthe market, for arbitrage or for

implementing strategies which can help in generating income for investors under various

market conditions.

Options are fundamentally different from forward and futures contracts. An option gives

the holder ofthe option the rightto do something. The holder does nothave to exercise this

right. In contrast, in a forward or futures contract, the two parties have committed

themselves to doing something. Whereas it costs nothing (except margin requirements) to

enter into a futures contract, the purchase of an option requires an upfront payment.

2.2. OPTIONS TERMINOLOGIES:

Index options:These options have the index as the underlying. In India, theyhave a

European style settlement. Eg. Nifty options, Mini Nifty options etc.

Stock options: Stock options are options on individual stocks. A stock option

contract gives the holderthe rightto buy or sell the underlying shares atthe

specified price. Theyhave an American style settlement.

Buyer of an option:The buyer of an option is the one who by paying the option

premium buys the right but notthe obligation to exercise his option on the

seller/writer.

Writer / seller of an option: The writer / seller of a call/put option is the one who

receives the option premium and is thereby obliged to sell/buythe asset ifthe buyer

exercises on him.


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Call option: A call option gives the holderthe right but notthe obligation to buy an

asset by a certain date for a certain price.

Put option: A put option gives the holderthe right but notthe obligation to sell an

asset by a certain date for a certain price.

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

Expiration date:The date specified in the options contract is known as the

expiration date, the exercise date, the strike date orthe maturity

Strike price:The price specified in the options contract is known as the strike price

orthe exercise price.

American options: American options are options that can be exercised at anytime

upto the expiration date.

European options: European options are options that can be exercised only on theexpiration date itself.

In-the-money option: An in-the-money (ITM) option is an option that would lead

to a positive cash-flow to the holder if it were exercised immediately. A call option

on the index is said to be in-the-money when the current index stands at a level

higherthan the strike price (i.e. spot price > strike price). Ifthe index is muchhigher

than the strike price, the call is said to be deep ITM. In the case of a put, the put is

ITM ifthe index is below the strike price.

At-the-money option: An at-the-money (ATM) option is an option that would lead

to zero cash-flow if it were exercised immediately. An option on the index is at-the-

money when 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

would lead to a negative cash-flow if it were exercised immediately. A call option

on the index is out-of-the-money when the current index stands at a level which is

less than the strike price (i.e. spot price < strike price). Ifthe 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 ifthe index is above the strike price.

Time value of an option:The time value of an option is the difference between its

premium and its intrinsic value. Both calls and puts have time value. An option that

is OTM or ATM has onlytime value. Usually, the maximum time value exists when

the option is ATM. The longerthe time to expiration, the greater is an option's time

value, all else equal. At expiration, an option should have no time value.


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3.Trading in options

3.1. A long position in a call option

In this strategy, the investorhas the rightto buythe asset in the future at a

predetermined strike price i.e., strike price (K) and the option sellerhas the

obligation to sell the asset atthe strike price (K). Ifthe settlement price

(underlying stock closing price) ofthe asset is above the strike price, then the

call option buyer will exercise his option and buythe stock atthe strike price

(K). Ifthe settlement price (underlying stock closing price) is lowerthan the

strike price, the option buyer will not exercise the option as he can buythe same

stock from the market at a price lowerthan the strike price.

3.2. A long position in a put option

In this strategy, the investorhas boughtthe rightto sell the underlying asset in

the future at a predetermined strike price (K). Ifthe settlement price (underlying

stock closing price) at maturity is lowerthan the strike price, then the put option

holder will exercise his option and sell the stock atthe strike price (K). Ifthe

settlement price (underlying stock closing price) is higherthan the strike price,

the option buyer will not exercise the option as he can sell the same stock in the

market at a price higherthan the strike price.


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3.3. A short position in a call option

In this strategy, the option sellerhas an obligation to sell the asset at a

predetermined strike price (K) ifthe buyer ofthe option chooses to exercise the

option. The buyer ofthe option will exercise the option ifthe spot price at

maturity is any value higherthan (K). Ifthe spot price is lowerthan (K), the

buyer ofthe option will not exercise his/her option.

3.4. A short position in a put option

In this strategy, the option sellerhas an obligation to buythe asset at a

predetermined strike price (K) ifthe buyer ofthe option chooses to exercise

his/her option. The buyer ofthe option will exercise his option to sell at (K) if

the spot price at maturity is lowerthan (K). Ifthe spot price is higherthan (K),

then the option buyer will not exercise his/her option.

3.5.Settlement of Options

In an options trade, the buyer ofthe option pays the option price orthe option

premium. The options sellerhas to deposit an initial margin withthe clearing

member as he is exposed to unlimited losses. There are basicallythree types of

settlement in stock option contracts: daily premium settlement, exercise

settlement and interim exercise settlement. In index options, there is no interim

exercise settlement as index options cannot be exercised before expiry.


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Daily premium settlement

Buyer of an option is obligated to paythe premium towards the options

purchased byhim. Similarly, the seller of an option is entitled to receive the

premium forthe options sold byhim. The same person may sell some contracts

and buy some contracts as well. The premium payable and the premium

receivable are netted to compute the net premium payable or receivable for each

client for each options contract atthe time of settlement.

Exercise settlement

Normally most option buyers and sellers close outtheir option positions by an

offsetting closing transaction but a better understanding ofthe exercise

settlement process can help in making better judgment in this regard. There are

two ways an option can be exercised. One way of exercising is exercise atthe

expiry ofthe contract;the other is an interim exercise, which is done before

expiry. Stock options can be exercised in both ways where as index options can

be exercised only atthe end ofthe contract.

a. Final Exercise Settlement

On the day of expiry, all in the money options are exercised by default. An

investor who has a long position in an in-the-money option on the expiry date

will receive the exercise settlement value which is the difference between the

settlement price and the strike price.


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Similarly, an investor who has a short position in an in-the-money option will

have to paythe exercise settlement value. The final exercise settlement value

for each ofthe in the money options is calculated as follows:

Call Options = Closing price ofthe security on the day of expiry strike price

Put Options = Strike price closing price ofthe security on the day of expiry

Example:

Suppose a call option on Reliance Industries has a Strike price of Rs. 2000, and

the closing price is Rs. 2500 on the day of expiry, then the final exercise

settlement value ofthe call option is:

V = 2500 2000 = 500.

b. Interim Exercise Settlement

Interim exercise settlementtakes place only for stock options and not for index

options. An investor can exercise his in-the-money options at anytime during

trading hours. Interim exercise settlement is effected for such options atthe

close oftrading hours, on the same day. When a long option holder exercises

his option it is the stock exchange which pays the option holder and receives

equivalent amount from one ofthe short option investors through assignment

process. In this case assignment process is the process of selecting a short

investor randomly and forcing him to paythe settlement amount. The client

who has been assigned the contracthas to paythe settlement value which is the

difference between closing spot price and the strike price.


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The interim exercise settlement value for each ofthe in the money options is

calculated as follows:

Call Options = Closing price ofthe security on the day of exercise strike price

Put Options = Strike price closing price ofthe security on the day of exercise


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4.Option Spreads

Options Spreads are combinations oftwo or more opposite positions in options of

the same type (i.e. calls or puts) on the same underlying. These spreads positions

may be categorized as follows:

Vertical Spread

Horizontal Spread

Diagonal Spread

Vertical Spread

Vertical spread is a spread position in whichtwo legs ofthe spread have different

strike prices butthe same expiration date.

For instance:

One may buy a December call option on scrip X with strike price Rs. 100 and sell

another December call option on scrip X with strike price Rs. 110. This will

amountto establishing a vertical option spread.


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Horizontal Spread

Horizontal Spread is a spread in whichtwo legs ofthe spread have different

expiration dates butthe same strike price.

For instance:

One may sell a December call option on scrip X with strike price Rs. 100 and buy

a January call option on scrip X with strike Rs.100. This will result in establishing

a horizontal option spread. This spread is also called time spread or calendar

spread.

Diagonal Spread

Diagonal Spread is a spread in whichtwo legs ofthe spread have different strike

prices and different expiration dates.

For instance:

One may sell a December call option on scrip X with strike Rs. 110 and buy a

January call option on scrip X with strike Rs. 100. This will establish a diagonal

option spread. This position has features of both vertical and horizontal spreads

and maytherefore be called a hybrid product.


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5.PHYSICAL GOLD VS GOLD ETF

Since years people have been buying gold the traditional way in the form of

jewellery or gold biscuits and coins. Then the natural question that will come to

ones mind will be why should I buy gold through gold ETF units in demat(electronic) format. Taking the delivery of gold ETF units in demat format over

physical gold comes with its own advantages like:

1) In case of gold ETFs the person need not worry aboutthe purity and

quality ofthe gold. This aspect is taken care of bythe stock exchange and

the other regulators. There is no impurity risk of any sort in buying gold

ETFs. The gold ETF mutual fund invests in standard gold bullion

(99.5% purity).

2) Since the investor is nottaking physical deliveryhe need not worry

about storing physical gold at a safe place. Imagine that ifyou go onaccumulating one gram of physical gold every month; after16 years you

will have almost 200 grams of physical gold to take care of. Ifyou keep

this gold athome, its bound to give you sleepless nights. But since in

gold ETFs the physical delivery aspect is taken care of;you can enjoy

sound sleep at night and leave the worry of guarding your gold to the

mutual fund AMC.

3) Also you need not spend money on gold insurance and bank locker rent

as there is no physical delivery of gold involved.

4) Y

ou can buy gold ETF units atthe market price. Normally ifyou buygold coins or biscuits from banks or jewellers;their prices are different

from each other. Also some banks normally charge a premium of 3-5%

overthe market price of gold. So the gold ETF pricing is very

transparent.

5) Similarly when you sell gold ETF units you can sell them atthe current

market price. There are no cutting charges or making charges orthere is

no discountto market price atthe time of selling the gold ETF units. This

ensures thatyou get a fair price foryour gold atthe time of selling. Also

there are ready buyers available throughthe exchange foryour gold at

any given point oftime. So this ensures adequate liquidity and you cansell your gold ETF units at any point oftime without any loss of value or

very little loss of value. Banks normally dont buy back gold sold by

them. Jewellers do buy back gold but at a discountto the market price.


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6) With gold ETFs at a time you can buy as low as 1 gram of gold orhalf a

gram of gold at a time. Ifyou buy gold in the form of coins or biscuits

you mayhave to buy a minimum of 5 grams of gold at a time. Buying

half a gram of gold through gold ETF every month is within the reach of

common man; but buying 5 grams of physical gold every month may not

be within the reach of everyone. So the low entry point offered by gold

ETFs is definitely an advantage as compared to physical gold.

7) Ifthe value ofyour physical gold goes above a certain level (presently

Rs 15 lakhs) then you are liable to pay wealthtax. But investing in gold

through gold ETFs does not attract any wealthtax.

8) Ifyou buy physical gold and hold it for less than 36 months and sell it;

you are liable to pay shortterm capital gains tax. But in case of gold

ETFs ifthe person holds the gold ETF units for more than 12 months

then he has to pay long term capital gains tax. So from tax point of view

also gold ETFs have an edge over physical gold.

So you see buying gold through gold ETFs ratherthan traditional ways (jewellery

or gold coins and biscuits) has lot of advantages.

The ETF holder (investor) justhas to pay an annual expense ofthe scheme which

is also known as fund management charges. This charge is in the range of0.5% to

1.5% per annum.

Until January 2008, the stock markets witnessed an almost secular bull run for

nearly five years. That was the time when equity-linked investment avenues werefavorites with investors. Ittook a sharp fall in equity markets for investors to look

beyond equities and consider other investment avenues. Since then, gold is an asset

class thathas attracted a lot of attention. The reasons forthe same are not difficult

to guess.

From its peak in January8, 2008, the BSE Sensex is down by nearly 54% till date.

On the other hand, gold has appreciated by almost 25% over the same period.

Expectedly, gold has caughtthe investors fancy. At PersonalFN, we have received

a number of queries from investors wanting to know how they can invest in gold.

In this article, we discuss the Gold Exchange Traded Fund (Gold ETF) route of

investing in gold.


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y Options for investing in gold

Nottoo long ago, buying physical gold was the only option for investing in gold.

However, the launch of Gold ETFs threw open another option for investors. Gold

ETFs are open-ended funds whichtrack prices of gold. They are listed and traded

on a stock exchange;hence, they can be bought and sold like stocks on a real-time

basis. These funds are passively managed and they mirror domestic gold prices. By

enabling investors to invest in gold withoutholding it in physical form, Gold ETFs

offer a rather unique investment opportunityto investors.

Advantages of Gold ETFs

Although the mode chosen for investing in gold would entirely depend on

investors, Gold ETFs do offer some distinct advantages vis--vis investing in

physical gold.

1. Convenience: Gold ETFs are a convenient means of investing in gold. Since

there is no delivery involved, investors do nothave to worry aboutthe storage and

security aspects that are typically associated with investing in physical gold.

2. Quality: As per SEBI regulations, the purity of underlying gold in Gold ETFs

should be 0.995 fineness and above. This spares investors the trouble of finding a

reliable source to buy gold.

3. No premium: Jewellers and banks generally sell gold at a premium. Thepremium can be in the range of 5%-10% (inclusive of making charges) in case of

jewellers and upto 15% in case of banks. Since Gold ETFs are traded on the stock

exchange, they can be bought at the prevailing market rate without paying any

premium.

4. Low cost: To store physical gold, one would typically need a locker. This

expense is over and above the premium paid at the time of buying physical gold.

As for Gold ETFs, a pre-requisite is to have demat and trading accounts with a

broker. To maintain these accounts, investors are required to pay annual charges,

which vary from brokerto broker. Investors also have to paythe brokerage on eachtrade. Finally, there are annual recurring charges which are charged to the fund.

Considering the premium and other charges borne while buying physical gold,

investing via Gold ETFs can turn outto be a more cost-effective option.


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5. Transparent pricing:The pricing of physical gold varies depending on the

vendor. Conversely, Gold ETFs have a transparent pricing mechanism.

International gold prices are converted to Indian landed price using the applicable

exchange rate. Various duties and taxes are also added to arrive atthe landed price

of gold.

6. Tax efficiency: In Gold ETFs, long-term capital gains tax is applicable after

twelve months from the date of purchase vis--vis three years in the case of

physical gold. Also, unlike physical gold, investments in Gold ETFs are not subject

to WealthTax.

7. Resale value: Gold ETFs can be easily sold in the secondary market on a real-

time basis (i.e. at the prevailing market price). Whereas, while selling physical

gold, the jeweller will deduct making charges (the charge that is added while

buying gold). As regards banks, they refuse to buy back gold.

Tax implications

Tax implications on Gold ETFs are same as those on debt mutual funds. A unit of a

Gold ETF that is held for less than twelve months is treated as a short-term capital

asset. Gains on the same are taxed atthe investors marginal rate oftax. Units held

for more than twelve months are treated as long-term capital assets. Long-term

capital gains are taxed at 20% (after allowing for indexation benefit) or 10%

(without indexation benefit), whichever is less.

Criteria for selecting a Gold ETF

Following are some ofthe factors that investors must consider before investing in a

Gold ETF.

a. Percentage of holdings in physical gold

Ideally, investors must select a Gold ETF that holds a significant portion of its

portfolio in gold over ones thattake cash calls i.e. invests in current assets.

b. Expense Ratio

Investors must choose a fund whichhas a lower expense ratio. Higher expenses

translate into lower returns for investors.


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Appendix

Appendix 1: Kotak Gold ETF

Appendix 2: Reliance Gold ETF

Appendix 3: Religare Gold ETF

Appendix 4: Physical Gold Prices

References

1) www.nseindia.com

2) www.bseindia.com

3) www.yahoofinance.com

4) www.moneycontrol.com5)Book: John . C. Hull

sneh summer report (Repaired)

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