A Study On Financial Derivative and Risk Management

TABLE OF CONTENTS
CHAPTER
TITLE
NO.
1
1.1
1.2
1.3
1.4
2
3
4
INTRODUCTION
General introduction
Objective of the study
Scope of the study
Limitations
COMPANY PROFILE
DERIVATIVES
FINDINGS,SUGGESTIONS &
PAGE NO.
7-10
7
9
9
10
12-28
29-99
100-103
CONCLUSION
BIBLIOGRAPHY
105
CHAPTER 1
INTRODUCTION
General introduction
2
The liberalization of the Indian economy has ushered in an era of opportunities for
the Indian corporate sector. however, these opportunities are accomplished by challenges. The
corporate are now required to operate at global capacities to be able to reap the benefits of
economies of scale and be competitive. To operate at global capacities, huge investments are
called for and the main source of fund in the public at large. Therefore, the corporate now started
tapping the capital market in a big way. The response is also encouraging.
As the Indian nation integrates with world economy era, small tremors in the world
market starts affecting the Indian economy. As an example, interest rates have been south bound
in the world and the same has happened in the Indian market too. fixed income rates have fallen
drastically due to fall in the real income of people. To overcome this fall , investors have been
continuously seek to increase the yield of their of their investments. But, it is a time-tested fact
that, the yields on investment in equity shares are maximum, the accompanying risks are also
maximum. Therefore, it is absolutely essential that efforts should be made to reduce this factor.
The reduction of risk can be achieved through the process of hedging using
derivatives financial instrument. A hedge is any act that reduced the price risk of an existing or
anticipated position in the cash market. Basically, there are two type of hedging with futures
:long hedge and short hedge.
Financial derivatives are a kind of risk management instrument. A derivative's

value depends on the price changes in some more fundamental underlying assets. Many forms of
financial derivatives instruments exist in the financial markets. Among them, the three most
fundamental financial derivatives instruments are: forward contracts, futures, and options. If the
underlying assets are stocks, bonds, foreign exchange rates and commodities etc., then the
3
corresponding risk management instruments are: stock futures (options), bond futures (options),
currency futures (options) and commodity futures (options) etc. In risk management of the
underlying assets using financial derivatives, the basic strategy is hedging, i.e., the trader holds
two positions of equal amounts but opposite directions, one in the underlying markets, and the
other in the derivatives markets, simultaneously. This risk management
strategy is based on the following reasoning: it is believed that under normal circumstances,
prices of underlying assets and their derivatives change roughly in the same direction with
basically the same magnitude; hence losses in the underlying assets (derivatives) markets can be
offset by gains
in the derivatives (underlying assets) markets; therefore losses can be prevented or reduced by
combining the risks due to the price changes. The subject of this book is pricing of financial
derivatives and risk management by hedging.
SCOPE OF THE STUDY

Introduction of derivatives in the Indian capital market is the beginning of a new era ,
which is truly exciting. Derivatives, worldwide are recognized risk management products. These
products have a long history in India, in the unorganized sector , especially in currency and
4
commodity markets. The availability of these products on organized exchanges ha provided the
market participants with broad based risk management tools.
This study mainly covers the area of hedging and speculation. The main aim of the
study is to prove how risks in investing in equity shares can be reduced and how to make
maximum return to the other investment.
IMPORTANCE OF THE STUDY
It helps the researcher to construct a diversified portfolio.

Provide an insight on return and risk analysis.
It helps to make a general study on derivatives.
It helps to identify and reduce by using hedging strategies and speculation.
OBJECTIVE OF THE STUDY
To find out extant to which loss can be reduced by applying hedging strategies.
To determine whether the hedger enjoys better returns from the use of hedgers.
To identify how much reduction in risk is possible.
To find out the extend of loss due to misjudgment on index movements .
LIMITATION OF THE STUDY

A) While applying the strategies , transaction cost and impact cost are not taken into
consideration.so,it will reflect in the profit calculation on each month of the study.
B) data were collected only on the basis of NSE trading
C) Hedging strategy is applied on historical data. so the direction of each trend in the stock
market is known before hand for the period selected. As a result, some bias could have
been done for the application of hedging strategy.
CHAPTER 2
COMPANY PROFILE
PROFILE OF THE COMPANY
INTRODUCTION
Mr. C.J. George and Mr. Ranajit Kanjilal founded Geojit as a partnership firm. In
1993, Mr.Ranajit Kanjilal retired from the firm and Geojit became the proprietary concern of Mr.
C .J. George. In 1994, it became a Public Limited Company named Geojit Securities Ltd. The
Kerala State Industrial Development Corporation Ltd. (KSIDC), in 1995, became a co-promoter
of Geojit by acquiring a 24 percent stake in the company, the only instance in India of a
government entity participating in the equity of a stock broking company. The year 1995 also
saw Geojit being listed on the leading regional stock exchanges. Geojit listed at The Stock
Exchange, Mumbai (BSE) in the year 2000. Companys wholly owned subsidiary, Geojit
Commodities Limited, launched Online Futures Trading in agri-commodities, precious metals
and energy futures on multiple commodity exchanges in 2003. This was also the year when the
company was renamed as Geojit Financial Services Ltd. (GFSL). The Board consists of
professional directors; including a Kerala Government nominee. With effect from July 2005, the
company is also listed at The National Stock Exchange (NSE). Company is a charter member of
the Financial Planning Standards Board of India and is one of the largest Depository
Participant(DP)..brokers..in..the..country.
On 31st December 2007, the company closed its commodities business and surrendered its
membership in the various commodity exchanges held by Geojit Commodities Ltd. Global
banking major BNP Paribas took a stake in the year 2007 to become the single largest
shareholder. Consequently, Geojit Financial Services Limited was renamed as Geojit BNP
Paribas Financial Services Ltd.
ABOUT BNP PARIBAS

BNP Paribas is the Eurozones leading bank in terms of deposits, and one of the 10
most important banks in the world in terms of net banking income, equity capital and market
value. Furthermore, it is one of the 6 strongest banks in the world according to Standard &
Poor's. With a presence in 85 countries and more than 205,000 employees, 165,200 of which in
Europe, BNP Paribas is a global-scale European leader in financial services. It holds key
positions in its three activities: Retail banking, Investment Solutions and Corporate & Investment
Banking. The Group benefits from its four domestic markets: Belgium, France, Italy and
Luxembourg. BNP Paribas also has a significant presence in the United States and strong
positions in Asia and the emerging markets.
BNP Paribas has been operating in India since 1860 in a number of businesses such as
Investment Banking (CIB), Private banking (BNP Paribas Wealth Management), Life Insurance
(SBI Life) and Asset Management (Sundaram BNP Paribas), Infrastructure Funding (Srei BNP
Paribas), Retail Financing (Sundaram BNP Paribas Home Finance), Car Contract Hiring (Arval),
Institutional Broking (BNP Paribas Securities India) and Securities Services (Sundaram BNP
Paribas Securities Services and BNP Paribas Sundaram Global Securities Operations).
Retail..Financial..Services..Player
Geojit BNP Paribas today is a leading retail financial services company in India with a
growing presence in the Middle East. The company rides on its rich experience in the capital
market to offer its clients a wide portfolio of savings and investment solutions. The gamut of
value-added products and services offered ranges from equities and derivatives to Mutual Funds,
Life & General Insurance and third party Fixed Deposits. The needs of over 460 000 clients are
met via multichannel services - a countrywide network of 500 offices, phone service, dedicated
Customer..Care..centre..and..the..Internet.
9
Geojit BNP Paribas has membership in, and is listed on, the National Stock Exchange (NSE)
and the Bombay Stock Exchange (BSE). In 2007, global banking major BNP Paribas joined the
companys other major shareholders - Mr. C.J.George, KSIDC (Kerala State Industrial
Development Corporation) and Mr.Rakesh Jhunjhunwala when it took a stake to become the
single..largest..shareholder.
Strategic joint ventures and business partnerships in the Middle East has provided the
company access to the large Non-Resident Indian(NRI) population in the region. Now, as a part
of the BNP Paribas global network, Geojit BNP Paribas is well positioned to further expand its
reach to NRIs in 85 countries. Barjeel Geojit Securities is the joint venture with the Al Saud
group in the United Arab Emirates that is headquartered in Dubai with branches in Abu Dhabi,
Ras Al Khaimah, Sharjah and Muscat. Aloula Geojit Brokerage Company headquartered in
Riyadh is the other joint venture with the Al Johar group in Saudi Arabia. The company also has
a business partnership with the Bank of Bahrain and Kuwait, one of the largest retail banks in
Bahrain..and..Kuwait.
At the forefront of the many fruitful associations between Geojit BNP Paribas and BNP
Paribas is their joint venture, namely, BNP Paribas Securities India Private Limited. This JV was
created exclusively for domestic and foreign institutional clients. An industry first was achieved
when Geojit BNP Paribas became the first broker in India to offer full Direct Market
Access(DMA)
on
NSE
to
the
JVs
institutional
clients.
A strong brand identity and extensive industry knowledge coupled with BNP Paribas
international
expertise
gives
Geojit
BNP
Paribas
competitive
advantage.
Expanding..range..of..online..products..and..services
Geojit BNP Paribas has proven expertise in providing online services. In the year 2000, the
company was the first stock broker in the country to offer Internet Trading. This was followed
by integrating the first Bank Payment Gateway in the country for Internet Trading, and many
10
other industry firsts. Riding on this experience, and harnessing BNP Paribas Personal Investors
expertise as the leading online broker in Europe, is helping the company to rapidly expanding its
business in this segment. Presently, clients can trade online in equities, derivatives, currency
futures, mutual funds and IPOs, and select from multiple bank payment gateways for online
transfer of funds. Strategic B2B agreements with Axis Bank and Federal Bank enables the
respective banks clients to open integrated 3-in-1 accounts to seamlessly trade via a
sophisticated..Online..Trading..platform.
Further, deployment of BNP Paribas state-of-the-art globally accepted systems and processes is
already
scaling
up
the
sales
of
Mutual
Funds
and
Insurance.
Wide..range..of..products..and..services
Certified financial advisors help clients to arrive at the right financial solution to meet their
individual needs. The wide range of products and services on offer includes Equities | Derivatives | Currency Futures | Custody Accounts | Mutual Funds | Life Insurance &
General Insurance | IPOs | Portfolio Management Services | Property Services | Margin Funding
|Loans..against..Shares
A..growing..footprint
With a presence in almost all the major states of India, the network of 500 offices across 300
cities and towns presently covers Andhra Pradesh, Bihar, Chattisgarh, Goa, Gujarat, Haryana,
Jammu & Kashmir, Karnataka, Kerala, Madhya Pradesh, Maharashtra, New Delhi, Orissa,
Punjab, Rajasthan,Tamil Nadu & Pondicherry, Uttar Pradesh, Uttarakhand and West Bengal.
11
OVERSEAS JOINT VENTURES
Barjeel geojit securities, LLC Dubai, is a joint venture of geojit with al Saud group
belonging to sultan bin saud AL Qassemi having diversified interests in the area of equity
markets, real estates and trading. Barjeel geojit is a financial intermediary and the first
licensed brokerage company in USA.
It has facilities for off-line and on-line trading in Indian capital market and also in US,
European and far-eastern capital markets. it also provides depository services and deals in
Indian and international funds. An associate company, global financial investments
S.A.O.G provides similar services in Oman.
Aloua geojit brokerage company, is geojits recently promoted joint venture in Saudi
Arabia with the al johar group. Saudi is home to the worlds single largest NRI
population. The new venture is expected to start operations in the latter half of 2008.
The Saudi national and the NRI would be able to invest in the Saudi capital market. The
NRI would also be able to invest in the Indian stock market and in Indian mutual funds.
This joint venture makes geojit the first Indian stock broking company to commence
domestic retail brokerage operations in any foreign country.
OVERSEAS BUSINESS ASSOCIATION
Bank of Bahrain and Kuwait(BBK), one of the largest retail banks in Bahrain&
Kuwait through its NRI-Business, and geojit entered into an exclusive agreement in
September 2007. This association will provide the banks sophisticated client base, the
opportunity to diversify their holdings through investments in the Indian stock market.
Services offered are investment advisory,portfolio management, mutual funds, trading in
Indian equity market, demat and bank account, offline share transactions and PAN
CARD.
12
MILESTONES BY GEOJIT BNP PARIBAS
1986
Membership in Cochin Stock Exchange (CSE).
1994
Becomes a Public Limited Company named Geojit Securities Ltd.
1995
Kerala State Industrial Development Corporation Ltd.(KSIDC) acquires 24 percent

equity stake.
Membership in National Stock Exchange (NSE).
Public Issue
1996
Launch of Portfolio Management Services with SEBI registration.
1997
Depository Participant (DP) under National Securities Depository Limited.
1999
Membership in Bombay Stock Exchange (BSE).
2000
BSE Listing.
1st broking firm in India to offer online trading facility.
Commences Derivative Trading with NSE.
Integrates the 1st Bank Payment Gateway in the country for Internet Trading.
2001
13
Becomes India's first DP to launch depository transactions through Internet.
Establishes Joint Venture in the UAE to serve NRI customers.
2002
1st in India to launch an integrated internet trading system for Cash & Derivatives
segments.
2003
Geojit Commodities Limited, wholly owned subsidiary, launched Online Futures Trading
in agri-commodities, precious metals and in energy futures on multiple commodity
exchanges.
National launch of online futures trading in Rubber, Pepper, Gold, Wheat and Rice.
Company renamed as Geojit Financial Services Ltd.
2004
National launch of online futures trading in Cardamom.

2005
NSE Listing.
Geojit Credits, a subsidiary, registers with RBI as a Non-Banking Financial Company

(NBFC).
National launch of online futures trading in Coffee.
2006
Charter member of the Financial Planning Standards Board of India.
2007
BNP Paribas takes a stake in the companys equity, making it the single largest
shareholder.
Establishes Joint Venture in Saudi Arabia to serve the Saudi national and the NRI.
14
2008
BNP Paribas Securities India (P) Ltd. a Joint Venture with BNP Paribas S.A. for
Institutional Brokerage.
1st brokerage to offer full Direct Market Access execution in India for institutional
clients.
2009
Launch of Property Services division.
Launch of online trading in Currency Derivatives.
Consequent to BNP Paribas becoming the largest stakeholder in Geojit Financial Services,
company is renamed as Geojit BNP Paribas Financial Services Ltd.
BOARD OF DIRECTORS
Mr. A. P. Kurian
Non - Executive & Independent Chairman
Mr. C. J. George
Managing Director & Chief Promoter
Mr. Manoj Joshi
Non - Executive & Independent Director
Mr. Mahesh Vyas
Mr. Rakesh Jhunjhunwala
Non - Executive Director)
Mr. Ramanathan Bupathy
Mr. Punnoose George
Non - Executive Director

15
Mr. Olivier Le Grand
Mr. Pierre Rousseau
MANAGEMENT
Name
Designation
Mr. C. J. George
Managing Director
Mr. Satish Menon
Director (Operations)
Mr. A. Balakrishnan
Chief Technology Officer
Mr. K. Venkitesh
National Head - Distribution
Mr. Stefan Groening
Director (Planning and Control)
Mr. Jean-Christophe G
Director (Marketing)
Mr. Binoy .V.Samuel
Chief Financial Officer
Mrs. Jaya Jacob Alexander
Chief of Human Resources
CODE OF CONDUCT FOR THE DIRECTORS AND SENIOR OFFICERS

As per Clause 49 of the Listing Agreement with the Stock Exchanges, it shall be
obligatory for the Board of Directors of all listed Companies to lay down a code of conduct for
all Board members and senior management of the Company in order to ensure good Corporate
Governance.
I. CORPORATE GOVERNANCE Corporate governance is about commitment to values and
about ethical business conduct. It is about how an organization is managed. This includes its
corporate and other structures, its culture, its policies and the manner in which it deals with
various stakeholders. Accordingly, timely and accurate disclosure of information regarding the
financial situation, performance, ownership and governance of the company, is an important part
of corporate governance. This improves public understanding of the structure, activities and
policies of the organization. Consequently, the organization is able to attract investors, and to
enhance
the
trust
and
confidence
of
the
stakeholders.
16
We believe that sound corporate governance is critical to enhance and retain investor trust.
Accordingly, we always seek to attain our performance rules with integrity. The Board extends
its fiduciary responsibilities in the widest sense of the term. Our disclosures always seek to attain
the best practices in international corporate governance. We are also responsible to enhance long
term shareholder value and respect minority rights in all our business decisions.
II.
INTRODUCTION
OF
CODE
(Preamble)
This Code of Ethics for Directors and Senior Executives (the Code) helps to maintain the
standards of business conduct for Geojit BNP Paribas Financial Services Limited (the
Company) and ensures compliance with legal requirements particularly of Companies Act,
SEBI Regulations and the Listing Agreement with Stock Exchanges. The purpose of the Code is
to deter wrongdoing and promote ethical conduct. The matters covered in this Code are of utmost
importance to the Company, our shareholders and our business partners. Further, these are
essential so that we can conduct our business in accordance with our stated values.
The Code is applicable to the following persons, referred to as Officers :
Directors of the Company
Our Senior Management
Members of the Board of Subsidiary Company
Ethical business conduct is critical to our business. Accordingly, Officers are expected to read
and understand this Code, uphold these standards in day-to-day activities, and comply with all
applicable laws, rules and regulations, the Geojit BNP Paribas Code of Conduct, Service rules
and all applicable policies and procedures adopted by the Company that govern the conduct of its
employees.
Because the principles described in this Code are general in nature, Officers should also review
the
Companys
other
applicable
policies
and
procedures.
Officers should sign the acknowledgment form at the end of this Code and return the form to the
17
HR department indicating that they have received, read and understood, and agree to comply
with the Code. The signed acknowledgement form should be available with officers concerned.
Each year, as part of their annual review, Officers will be asked to sign an acknowledgement
indicating
III.
their
continued
understanding
HONEST
AND
and
adherence
of
the
ETHICAL
code.
CONDUCT
We expect all Officers to act in accordance with highest standards of personal and professional
integrity, honesty and ethical conduct, while working on the Companys premises, at offsite
locations where the Companys business is being conducted, at Company sponsored business and
social events, or any other place where Officers are representing the Company.
We consider honest conduct to be conduct that is free from fraud or misrepresentation or
deception. We consider ethical conduct to be conduct conforming to the accepted professional
standards of conduct. Ethical conduct includes ethical handling of actual or apparent conflicts of
interest between personal and professional relationships. This is discussed in more detail in
Section..IV..below.
IV.CONFLICTS..OF..INTEREST
An Officers duty to the Company demands that he or she avoids and discloses actual and
apparent conflicts of interest. A conflict of interest exists where the interests or benefits of one
person or entity conflict with the interests or benefits of the Company. Examples include:
A. Employment/Outside employment:With regard to the employment with the Company,
Officers are expected to devote their full attention to the business interests of the
Company. Officers are prohibited from engaging in any activity that interferes with their
employment with the Company. Our policies prohibit Officers from accepting
simultaneous employment with suppliers, customers, developers or competitors of the
Company, or from taking part in any activity that enhances or supports a competitors
position. Additionally, Officers must disclose to the Companys Audit Committee, any
interest that they have that may conflict with the business of the Company.
18
B. Outside directorships: It is a conflict of interest to serve as a director of any company that

competes with the Company. Officers must first obtain approval from the Companys
audit committee before accepting a directorship.
C. Business Interests: If an Officer is considering investing in any customer, supplier,

developer or competitor of the Company, he or she must first take care to ensure that
these investments do not compromise on their responsibilities to the Company. Our
policy requires that Officers first obtain approval from the Companys Audit Committee
before making such an investment. Many factors should be considered in determining
whether a conflict exists, including the size and nature of the investments, the Officers
ability to influence the Companys decisions, his or her access to confidential information
of the Company or of the other company, and nature of the relationship between the
Company and the other company. At the time of application for approval, full facts of the
proposed investment shall be placed before the Committee.
D. Related parties: As a general rule, Officers should avoid conducting Companys business
with a relative, or have business in which a relative is associated in any significant role. A
relative means and includes spouse, children, parents, grandparents, grandchildren, aunts,
uncles, nieces, nephews, cousins, step relationships, and in-laws. Subject to the rules and
regulation, the Company discourages the employment of relatives of Officers in key
positions or assignments within the same department. Further, the Company prohibits the
employment of such individuals in positions that have a financial dependence or
influence (e.g. an auditing or control relationship, or a supervisor/subordinate
relationship). Every employee drawing a monthly salary of Rs.10,000/- or more shall
disclose whether he is a relative or not of any of our directors.
E. Payments or gifts from others: Under no circumstance the Officers shall accept any offer,
payment, promise to pay, or authorisation to pay any money, gift, or anything of value
from customers, vendors, consultants, etc., that is perceived as intended, directly or
19
indirectly, to influence any business decision, any act or failure to act, any commitment
of fraud, or opportunity for the commitment of any fraud. Inexpensive gifts, infrequent
business meals, celebratory events and entertainment, provided that they are not
excessive or create an appearance of impropriety, do not violate this policy. Questions
regarding whether a particular payment or gift violates this policy are to be directed to
Finance Department. Gifts given by the Company to suppliers or customers should be
appropriate to the circumstances and should never be of a kind that could create an
appearance of impropriety. The nature and cost must always be accurately recorded in the
Companys books and records.
F. Corporate opportunities: Officers may not exploit for their own personal gain,
opportunities that are discovered through the use of corporate property, information or
position, unless the opportunity is disclosed fully in writing to the Companys Board of
Directors and the Board declines to pursue such opportunity.
G. Interested Contracts: Except with the consent of the Board of Directors of the Company,
any of the Director or his relative or a firm in which a director or his relative is a partner,
any other partner in such a firm, or a private company of which the director is a member
or director shall enter into any contract Whistle Blower Policy: Employees who came
across any unethical or improper practice (not necessarily a violation of law) shall be free
to approach the Audit Committee without necessarily informing their supervisors. All
officers are requested to inform their subordinates about their this right through an
effective manner. For any clarification in this regard please contact Finance Department /
Secretarial Department / Legal Department.
H. Other Situations: It would be impractical to attempt to list all possible situations. If a

proposed transaction or situation raises any questions or doubts, please contact Finance
Department.
20
I. V.
COMPLIANCE
WITH
GOVERNMENTAL
LAWS,
RULES
AND
REGULATIONS
Officers must comply with all applicable governmental laws, rules and regulations,
Officers must acquire appropriate knowledge of the legal requirements relating to their
duties sufficient to enable them to recognise potential dangers, and to know when to seek
advice from the Finance Department. Violations of applicable governmental laws, rules
and regulations will lead to penal action as specified in the respective statutes. In any
doubt about the compliance with laws rules/regulations /guidelines contact appropriate
department
of
the
Company.
VI.VIOLATIONS..OF..THE..CODE
Part of an Officers job, and of his or her ethical responsibility, is to help enforce
this Code. Officers should be alert against possible violations and report this to
appropriate department. Officers must co-operate in any internal or external
investigations of possible violations. Reprisal, threat, retribution or retaliation against any
person who has, in good faith, reported a violation or a suspected violation of law, this
Code or other Company policies, or against any person who is assisting in any
investigation
or
process
with
respect
to
such
violation,
is
prohibited.
The Company will take appropriate action against any Officer whose actions are
found to violate the Code or any other policy of the Company. Disciplinary actions may
include immediate termination of employment at the Companys sole discretion. Where
the Company has suffered a loss, it may pursue its remedies against the individuals or
entities responsible. Where laws have been violated, the Company will cooperate fully
with
VII.
the
WAIVERS
appropriate
AND
AMENDMENTS
authorities.
OF
THE
CODE
We are committed to continuously reviewing and updating our policies and

procedures. Therefore, this Code is subject to modification. Any amendment or waiver of
any provision of this Code must be approved in writing by the Companys Board of
Directors and promptly disclosed on the Companys website and in applicable regulatory
21
filings pursuant to applicable laws and regulations, together with details about the nature
of amendment or waiver. with the Company for sale, purchase or supply of goods,
materials or services, or for underwriting the subscription of any shares in or debentures
of the Company except for purchase or sale of goods for market price or such contracts
which either party regularly trades or does business. For any clarification in this regard,
the officers are requested to contact to the Finance Department / Secretarial Department /
Legal Department.
J. Whistle Blower Policy: Employees who came across any unethical or improper practice
(not necessarily a violation of law) shall be free to approach the Audit Committee without
necessarily informing their supervisors. All officers are requested to inform their
subordinates about their this right through an effective manner. For any clarification in
this regard please contact Finance Department / Secretarial Department / Legal
Department.
K. Other Situations: It would be impractical to attempt to list all possible situations. If a

proposed transaction or situation raises any questions or doubts, please contact Finance
Department.
V. COMPLIANCE WITH GOVERNMENTAL LAWS, RULES AND REGULATIONS
Officers must comply with all applicable governmental laws, rules and regulations, Officers must
acquire appropriate knowledge of the legal requirements relating to their duties sufficient to
enable them to recognise potential dangers, and to know when to seek advice from the Finance
Department. Violations of applicable governmental laws, rules and regulations will lead to penal
action as specified in the respective statutes. In any doubt about the compliance with laws
rules/regulations
/guidelines
contact
appropriate
department
of
the
Company.
VIVIOLATIONS..OF..THE..CODE
Part of an Officers job, and of his or her ethical responsibility, is to help enforce this Code.
Officers should be alert against possible violations and report this to appropriate department.
22
Officers must co-operate in any internal or external investigations of possible violations.

Reprisal, threat, retribution or retaliation against any person who has, in good faith, reported a
violation or a suspected violation of law, this Code or other Company policies, or against any
person who is assisting in any investigation or process with respect to such a violation, is
prohibited.
The Company will take appropriate action against any Officer whose actions are found to violate
the Code or any other policy of the Company. Disciplinary actions may include immediate
termination of employment at the Companys sole discretion. Where the Company has suffered a
loss, it may pursue its remedies against the individuals or entities responsible. Where laws have
been violated, the Company will cooperate fully with the appropriate authorities.
VII.
WAIVERS
AND
AMENDMENTS
OF
THE
CODE
We are committed to continuously reviewing and updating our policies and procedures.
Therefore, this Code is subject to modification. Any amendment or waiver of any provision of
this Code must be approved in writing by the Companys Board of Directors and promptly
disclosed on the Companys website and in applicable regulatory filings pursuant to applicable
laws and regulations, together with details about the nature of amendment or waiver.
23
CHAPTER 3
DERIVATIVES
24
DERIVATIVES
The word DERIVATIVES is derived from the word itself derived of a
underlying asset. It is a future image or copy of a underlying asset which may be shares, stocks,
commodities, stock indices, etc.
Derivatives is a financial product (shares, bonds) any act which is concerned with lending and
borrowing (bank) does not have its value borrow the value from underlying asset/ basic
variables.
Derivatives is derived from the following products:
A. Shares
B. Debuntures
C. Mutual funds
D. Gold
E. Steel
F. Interest rate
G. Currencies.
25
Derivatives is a type of market where two parties are entered into a contract one is bullish and
other is bearish in the market having opposite views regarding the market. There cannot be a
derivatives having same views about the market. In short it is like a INSURANCE market where
investors cover their risk for a particular position.
Derivatives are financial contracts of pre-determined fixed duration, whose values are derived
from the value of an underlying primary financial instrument, commodity or index, such as:
interest rates, exchange rates, commodities, and equities.
Derivatives are risk shifting instruments. Initially, they were used to reduce exposure to changes
in foreign exchange rates, interest rates, or stock indexes or commonly known as risk hedging.
Hedging is the most important aspect of derivatives and also its basic economic purpose. There
has to be counter party to hedgers and they are speculators. Speculators dont look at derivatives
as means of reducing risk but its a business for them. Rather he accepts risks from the hedgers in
pursuit of profits. Thus for a sound derivatives market, both hedgers and speculators are
essential.
Derivatives trading has been a new introduction to the Indian markets. It is, in a sense promotion
and acceptance of market economy, that has really contributed towards the growing awareness of
risk and hence the gradual introduction of derivatives to hedge such risks.
Initially derivatives was launched in America called Chicago. Then in 1999, RBI introduced
derivatives in the local currency Interest Rate markets, which have not really developed, but with
the gradual acceptance of the ALM guidelines by banks, there should be an instrumental product
in hedging their balance sheet liabilities.
The first product which was launched by BSE and NSE in the derivatives market was index
futures
INTRODUCTION TO FUTURE MARKET

26
Futures markets were designed to solve the problems that exit in forward markets. A
futures
con tract is an agreement between two parties to buy or sell an asset at a certain time in the future
at a certain price. There is a multilateral contract between the buyer and seller for a underlying
asset which may be financial instrument or physical commodities. But unlike forward contracts
the future contracts are standardized and exchange traded.
PURPOSE
The primary purpose of futures market is to provide an efficient and effective mechanism for
management of inherent risks, without counter-party risk.
It is a derivative instrument and a type of forward contract The future contracts are affected
mainly by the prices of the underlying asset. As it is a future contract the buyer and seller has
to pay the margin to trade in the futures market
It is essential that both the parties compulsorily discharge their respective obligations on the
settlement day only, even though the payoffs are on a daily marking to market basis to avoid
default risk. Hence, the gains or losses are netted off on a daily basis and each morning starts
with a fresh opening value. Here both the parties face an equal amount of risk and are also
required to pay upfront margins to the exchange irrespective of whether they are buyers or
sellers. Index based financial futures are settled in cash unlike futures on individual stocks which
are very rare and yet to be launched even in the US. Most of the financial futures worldwide are
index based and hence the buyer never comes to know who the seller is, both due to the presence
of the clearing corporation of the stock exchange in between and also due to secrecy reasons
EXAMPLE
The current market price of INFOSYS COMPANY is Rs.1650.
There are two parties in the contract i.e. Hitesh and Kishore. Hitesh is bullish and kishore is
bearish in the market. The initial margin is 10%. paid by the both parties. Here the Hitesh has
purchased the one month contract of INFOSYS futures with the price of Rs.1650.The lot size of
infosys is 300 shares.
Suppose the stock rises to 2200.
27
Profit
20
2200
10
0
1400 1500 1600 1700 1800 1900
-10
-20
Loss
Unlimited profit for the buyer(Hitesh) = Rs.1,65,000 [(2200-1650*3oo)] and notional profit for
the buyer is 500.
Unlimited loss for the buyer because the buyer is bearish in the market
Suppose the stock falls to Rs.1400

Profit
20
10
0
1400 1500 1600 1700 1800 1900
-10
-20
Loss
Unlimited profit for the seller = Rs.75,000.[(1650-1400*300)] and notional profit for the seller is
250.
28
Unlimited loss for the seller because the seller is bullish in the market.
Finally, Futures contracts try to "bet" what the value of an index or commodity will be at some
date in the future. Futures are often used by mutual funds and large institutions to hedge their
positions when the markets are rocky. Also, Futures contracts offer a high degree of leverage, or
the ability to control a sizable amount of an asset for a cash outlay, which is distantly small in
proportion to the total value of contract
MARGIN
Margin is money deposited by the buyer and the seller to ensure the integrity of the contract.
Normally the margin requirement has been designed on the concept of VAR at 99% levels. Based
on the value at risk of the stock/index margins are calculated. In general margin ranges between
10-50% of the contract value.
PURPOSE
The purpose of margin is to provide a financial safeguard to ensure that traders will perform on
their contract obligations.
TYPES OF MARGIN
INITIAL MARGIN:
It is a amount that a trader must deposit before trading any futures. The initial margin
approximately equals the maximum daily price fluctuation permitted for the contract being
traded. Upon proper completion of all obligations associated with a traders futures position, the
initial margin is returned to the trader.
OBJECTIVE
29
The basic aim of Initial margin is to cover the largest potential loss in one day. Both
buyer and seller have to deposit margins. The initial margin is deposited before the opening of
the position in the Futures transaction.
MAINTENANCE MARGIN:
It is the minimum margin required to hold a position. Normally the maintenance is lower than
initial margin. This is set to ensure that the balance in the margin account never becomes
negative. If the balance in the margin account falls below the maintenance margin, the investor
receives a margin call to top up the margin account to the initial level before trading
commencing on the next level.
EXAMPLE:On MAY 15th two traders, one buyer and seller take a position on June NSE S and P CNX nifty
futures at 1300 by depositing the initial margin of Rs.50,000with a maintenance margin of 12%.
The lot size of nifty futures =200.suppose on MAY 16th
The price of futures settled at
Rs.1950. As the buyer is bullish and the seller is bearish in the
market. The profit for the buyer will be 10,000 [(1350-1300)*200]

Loss for the seller will be 10,000[(1300-1350)]
Net Balance of Buyer = 60,000(50,000 is the margin +10,000 profit for the buyer)
Net Balance of Seller = 40,000(50,000 is the margin -10,000 loss for the seller)
Suppose on may 17th nifty futures settled at 1400.
Profit of buyer will be 10,000[(1450-1350)*200]
Loss of seller will be 10,000[(1350-1400)*200]
Net balance of Buyer =70,000(50, 000 is the margin +20,000 profit for the buyer)
Net Balance of Seller = 30,000(50,000 is the margin -20,000 loss for the seller)
30
As the sellers balance dropped below the maintenance margin i.e. 12% of 1400*200=33600
While the initial margin was 50,000.Thus the seller must deposit Rs.20,000 as a margin call.
Now the nifty futures settled at Rs.1390.
Loss for Buyer will be 2,000 [(1390-1400)*200]
Profit for Seller will be 2,000 [(1390-1400)*200]
Net balance of Buyer =68,000(70,000 is the margin -2000 loss for the buyer)
Net Balance of Seller = 52,000(50,000 is the margin +2000 profit for the seller)
Therefore in this way each account each account is credited or debited according to the
settlement price on a daily basis. Deficiencies in margin requirements are called for the broker,
through margin calls. Till now the concept of maintenance margin is not used in India.
ADDITIONAL MARGIN:
In case of sudden higher than expected volatility, additional margin may be called for by the
exchange. This is generally imposed when the exchange fears that the markets have become too
volatile and may result in some crisis, like payments crisis, etc. This is a preemptive move by
exchange to prevent breakdown.
CROSS MARGINING:
This is a method of calculating margin after taking into account combined positions in Futures,
options, cash market etc. Hence, the total margin requirement reduces due to cross-Hedges.
MARK-TO-MARKET MARGIN:
It is a one day market which fluctuates
on daily basis and on every scrip proper
evaluation is done. E.g. Investor has purchase the Wipro FUTURES. and pays the Initial margin.
Suddenly script of Wipro falls then the investor is required to pay the mark-to-market margin
also called as variation margin for trading in the future contract
31
32
HEDGERS :
Hedgers are the traders who wish to eliminate the risk of price change to which they are
already exposed.It is a mechanism by which the participants in the physical/ cash markets can
cover their price risk. Hedgers are those persons who dont want to take the risk therefore they
hedge their risk while taking position in the contract. In short it is a way of reducing risks when
the investor has the underlying security.
PURPOSE:
TO REDUCE THE VOLATILITY OF A PORTFOLIO, BY REDUCING THE RISK
Figure 1.1
Hedgers
Existing
Approach
SYSTEM
Peril &Prize
New
Approach
Peril &Prize
1) Difficult to
1) No Leverage
1)Fix price today to buy
1) Additional
offload holding
available risk
latter by paying premium.
cost is only
during adverse
reward dependant 2)For Long, buy ATM Put
premium.
market conditions
on market prices
Option. If market goes up,
as circuit filters
long position benefit else
limit to curtail losses.
exercise the option.
3)Sell deep OTM call option
with underlying shares, earn
premium + profit with increase prcie
Advantages
Availability of Leverage
33
STRATEGY:
The basic hedging strategy is to take an equal and opposite position in the futures market to the
spot market. If the investor buys the scrip in the spot market but suddenly the market drops then
the investor hedge their risk by taking the short position in the Index futures
HEDGING AND DIVERSIFICATION:

Hedging is one of the principal ways to manage risk, the other being diversification.
Diversification and hedging do not have have cost in cash but have opportunity cost. Hedging is
implemented by adding a negatively and perfectly correlated asset to an existing asset. Hedging
eliminates both sides of risk: the potential profit and the potential loss. Diversification minimizes
risk for a given amount of return (or, alternatively, maximizes return for a given amount of risk).
Diversification is affected by choosing a group of assets instead of a single asset (technically, by
adding positively and imperfectly correlated assets).
Example:Ram enters into a contract with Shyam that he sells 50 pens to Shyam for Rs.1000. The cost of
manufacturing the pen for Ram is only Rs. 400 and he will make a profit of Rs 600 if the sale is
completed.
COST
SELLING PRICE
PROFIT
400
1000
600
However, Ram fears that Shyam may not honour his contract. So he inserts a new clause in the
contract that if Shyam fails to honour the contract he will have to pay a penalty of Rs.400. And if
Shyam honours the contract Ram will offer a discount of Rs 100 as incentive.
34
Shyam defaults
Shyam honors
400 (Initial Investment)
600 (Initial profit)
400 (penalty from Shyam
(-100) discount given to Shyam
- (No gain/loss)
500 (Net gain)
Finally if Shyam defaults Ram will get a penalty of Rs 400 but Ram will recover his initial
investment. If Shyam honors the bill the ram will get a profit of 600 deducting the discount of
Rs.100 and net profit for ram is Rs.500. Thus Ram has hedged his risk against default and
protected his initial investment.
Now lets see how investor hedge their risk in the market
Example:
Say you have bought 1000 shares of XYZ Company but in the short term you expect that the
market would go down due to some news. Then, to minimize your downside risk you could
hedge your position by buying a Put Option. This will hedge your downside risk in the market
and your loss of value in XYZ will be set off by the purchase of the Put Option.
Therefore hedging does not remove losses .The best that can be achieved using hedging
is the removal of unwanted exposure, i.e.unnessary risk. The hedging position will make less
profits than the un-hedged position, half the time. One should not enter into a hedging strategy
hoping to make excess profits for sure; all that can come out of hedging is reduce risk.
HEDGING WITH OPTIONS:

Options can be used to hedge the position of the underlying asset. Here the options buyers are
not subject to margins as in hedging through futures. Options buyers are however required to pay
premium which are sometimes so high that makes options unattractive.
35
Example:With a market price of ACC Rs.600 the investor buys the 50 shares of ACC.Now the
investor excepts that price will fall by 100.So he decided to buy the put Option b y paying the
premium of Rs.25. Thus the investor has hedge their risk by purchasing the put Option. Finally
stock falls by 100 the loss of investor is restricted t the premium paid of Rs.2500 as investor
recovered Rs.75 a share by buying ACC put.
HEDGING STRATEGIES:
LONG SECURITY, SELL NIFTY FUTURES:

Under this investor takes a long position on the security and sell some amount of Nifty
Futures. This offsets the hidden Nifty exposure that is inside every long- security
position. Thus the position LONG SECURITY, SELL NIFTY is a pure play on the
performance of the security, without any extra risk from fluctuations of the market index.
Finally the investor has HEDGED AWAY his index exposure.
LONG SECURITY, SELL FUTURES

Here stock futures can be used as an effective risk management tool. In this case the
investor buys the shares of the company but suddenly the rally goes down. Thus to maximize the
risk the Hedger enters into a future contract and takes a short position. However the losses
suffers in the security will be offset by the profits he makes on his short future position.
Spot Price of ACC = 390

Market action
= 350
Loss
= 40
Strategy
= BUY SECURITY, SELL FUTURES
Two month Futures= 390
Premium
= 12
Short position
= 390
36
Future profit
= 40(390-350)
As the fall in the price of the security will result in a fall in the price of Futures. Now the Futures
will trade at a price lower then the price at which the hedger entered into a short position.
Finally the loss of Rs.40 incurred on the security hedger holds, will be made up the profits made
on his short futures position.
HAVE STOCK, BUY PUTS:
This is one of the simplest ways to take on hedge. Here the investor buys 100 shares of
HLL.The spot price of HLL is 232 suddenly the investor worries about the fall of price.
Therefore the solution is buy put options on HLL.
The investor buys put option with a strike of Rs.240. The premium charged is
Rs.10.Here the investor has two possible scenarios three months later.
1) IF PRICE RISES
Market action: 215
Loss
: 17(232-15)
Strike price : 240
Premium
: 08
Profit
: 17(240-215-8)
Thus loss he suffers on the stock will be offset by the profit the investor earns on the put
option bought.
2) IF PRICE RISES:
Market share : 250
Loss
: 10
Short position : 250(spot market)
Thus the investor has a limited loss(determined by the strike price investor chooses) and an
unlimited profit.
HAVE PORTFOLIO, SHORT NIFTY FUTURES:

Here the investor are holding the portfolio of stocks and selling nifty futures. In the case
of portfolios, most of the portfolio risk is accounted for by index fluctuations. Hence a
37
position LONG PORTFOLIO+ SHORT NIFTY can often become one-tenth as risky as the
LONG PORTFOLIO position.
Let us assume that an investor is holding a portfolio of following scrips as given below on
1st May, 2001.
Company
Beta
Amount of Holding ( in
Rs)
Infosys
1.55
400,000.00
Global Tele
2.06
200,000.00
Satyam Comp
1.95
175,000.00
HFCL
1.9
125,000.00
Total Value of Portfolio
1,000,000.00
Trading Strategy to be followed

The investor feels that the market will go down in the next two months and wants to protect him
from any adverse movement. To achieve this the investor has to go short on 2 months NIFTY
futures i.e he has to sell June Nifty. This strategy is called Short Hedge.
Formula to calculate the number of futures for hedging purposes is
Beta adjusted Value of Portfolio / Nifty Index level
Beta of the above portfolio
=(1.55*400,000)+(2.06*200,000)+(1.95*175,000)+(1.9*125, 000)/1,000,000
=1.61075 (round to 1.61)
Applying the formula to calculate the number of futures contracts
Assume NIFTY futures to be 1150 on 1st May 2001
= (1,000,000.00 * 1.61) / 1150
38
= 1400 Units
Since one Nifty contract is 200 units, the investor has to sell 7 Nifty contracts.
Short Hedge
Stock Market
Futures Market
1st May
Holds Rs 1,000,000.00 in
stock portfolio
Sell 7 NIFTY futures

contract at 1150.
25th June
Stock portfolio fall by 6%

to Rs 940,000.00
NIFTY futures falls by 4.5%

to 1098.25
Profit / Loss
Loss: -Rs 60,000.00
Profit: 72,450.00
Net Profit: + Rs 15,450.00
SPECULATORS:
If hedgers are the people who wish to avoid price risk, speculators are those who are willing to
take such risk. speculators are those who do not have any position and simply play with the
others money. They only have a particular view on the market, stock, commodity etc. In short,
speculators put their money at risk in the hope of profiting from an anticipated price change.
Here if speculators view is correct he earns profit. In the event of speculator not being covered,
he will loose the position. They consider
various factors such as demand supply, market
positions, open interests, economic fundamentals and other data to take their positions.
SPECULATION IN THE FUTURES MARKET
39
Speculation is all about taking position in the futures market without having the
underlying. Speculators operate in the market with motive to make money. They take:
Naked positions - Position in any future contract.
Spread positions - Opposite positions in two future contracts. This is a conservative

speculative strategy.
Speculators bring liquidity to the system, provide insurance to the hedgers and facilitate the price
discovery in the market.
Figure 1.2
Speculators
Existing
Approach
1) Deliver based
Trading, margin
trading& carry
forward transactions.
2) Buy Index Futures
hold till expiry.
SYSTEM
Peril &Prize Approach
1) Both profit &
loss to extent of
price change.
1)Buy &Sell stocks

on delivery basis
2) Buy Call &Put
by paying
premium
New
Peril &Prize
1)Maximum
loss possible
to premium
paid
Advantages
40
*Greater Leverage as to pay only the premium.

*Greater variety of strike price options at a given time.
EXAMPLE:Here the Speculator believes that stock market will going to appreciate.
Current market price of PATNI COMPUTERS = 1500
Strategy: Buy February PATNI futures contract at 1500
Lot size = 100 shares
Contract value = 1,50,000 (1500*100)
Margin = 15000 (10% of 150000)
Market action = rise to 1550
Future Gain:Rs. 5000 [(1550-1500)*100]
Market action = fall to 1400
Future loss: Rs.-10000 [(1400-1500)*100]
Thus the Speculator has a view on the market and accept the risk in anticipating of profiting from
the view. He study the market and play the game with the stock market
TYPES:
POSITION TRADERS:
These traders have a view on the market an hold positions over a period of as days until their
target is met.
DAY TRADERS:
. Day traders square off the position during the curse of the trading day and book the profits.
SCALPERS:
Scalpers in anticipation of making small profits trade a number of times throughout the day.
41
SPECULATING WITH OPTIONS:

A speculator has a definite outlook about future price, therefore he can buy put or call option
depending upon his perception about future price. If speculator has a bullish outlook, he will buy
calls or sell (write) put. In case of bearish perception, the speculator will put r write calls. If
speculators view is correct he earns profit. In the event of speculator not being covered, he will
loose the position. A Speculator will buy call or put if his price outlook in a particular direction is
very strong but if is either neutral or not so strong. He would prefer writing call or put to earn
premium in the event of price situations.
Example:Here if speculator excepts that ZEE TELEFILMS stock price will rise from present level of
Rs.1050 then he buys call by paying premium. If prices have gone up then he earns profit
otherwise he losses call premium which he pays to buy the call. if speculator sells that ZEE
TELEFILMS stock will come down then he will buy put on the stale price until he can write
either call or put.
Finally Speculators provide depth an liquidity to the futures market an in their absence; the price
protection sought the hedger would be very costly.
STRATEGIES:
BULLISH SECURITY,SELL FUTURES:
Here the Speculator has a view on the market. The Speculator is bullish in the market.
Speculator buys the shares of the company an makes the profit. At the same time the Speculator
enters into the future contract i.e. buys futures and makes profit.
Spot Price of RELIANCE = 1000
Value
Market action
= 1000*100shares = 1,00,000
= 1010
42
Profit
= 1000
Initial margin
= 20,000
Market action
= 1010
Profit
= 400(investment of Rs.20,000)
This shows that with a investment of Rs.1,00,000 for a period of 2 months the speculator makes
a profit of 1000 and got a annual return of 6% in the spot market but in the case of futures the
Speculator makes a profit of Rs.400 on the investment of Rs.20,000 and got return of 12%.
Thus because of leverage provided security futures form an attractive option for speculator.
BULLISH STOCK, BUY CALLS OR BUY PUTS:
Under this strategy the speculator is bullish in the market. He could do any of the following:
BUY STOCK
ACC spot price
No of shares
Price
Market action
Profit
Return
: 150
: 200
: 150*200 = 30,000
: 160
: 2,000
: 6.6% returns over 2months
BUY CALL OPTION:

Strike price
Premium
Lot size
Market action
Profit
Return
: 150
: 8
: 200 shares
:160
: (160-150-8)*200 = 400
: 25% returns over 2months
This shows that investor can earn more in the call option because it gives 25% returns over a
investment of 2months as compared to 6.6% returns over a investment in stocks
43
BEARISH SECURITY,SELL FUTURES:
In this case the stock futures is overvalued and is likely to see a fall in price. Here simple
arbitrage ensures that futures on an individual securities more correspondingly with the
underlying security as long as there is sufficient liquidity in the market for the security. If the
security price rises the future price will also rise and vice-versa.
Two month Futures on SBI = 240
Lot size
Margin
Market action
Future profit
=
=
=
=
100shares
24
220
20(240-220)
Finally on the day of expiration the spot and future price converges the investor makes a profit
because the speculator is bearish in the market and all the future stocks need to sell in the market.
BULLISH INDEX, LONG NIFTY FUTURES:
Here the investor is bullish in the index. Using index futures, an investor can BUY OR SELL
the entire index trading on one single security. Once a person is LONG NIFTY using the futures
market, the investor gains if the index rises and loss if the index falls.
1st July = Index will rise

Buy nifty July contract = 960
Lot =200
14th July nifty risen= 967.35
Nifty July contract= 980
Short position
=980
Profit
= 4000(200*20)
44
ARBITRAGEURS:
Arbitrage is the concept of simultaneous buying of securities in one market where the price is
low and selling in another market where the price is higher.
Arbitrageurs thrive on market imperfections. Arbitrageur is intelligent and knowledgeable person
and ready to take the risk He is basically risk averse. He enters into those contracts were he can
earn risk less profits. When markets are imperfect, buying in one market and simultaneously
selling in other market gives risk less profit. Arbitrageurs are always in the look out for such
imperfections.
In the futures market one can take advantages of arbitrage opportunities by buying from lower
priced market and selling at the higher priced market.
JM Morgan introduced EQUITY DERIVATIVES FUND called as ARBITRAGE FUND where
the investor buys the shares in the cash market and sell the shares in the future market.
ARBITRAGEURS IN FUTURES MARKET

Arbitrageurs facilitate the alignment of prices among different markets through operating in them
simultaneously.
Figure 1.3
Arbitrageurs
Existing
Approach
1) Buying Stocks in
one and selling in
another exchange.
SYSTEM
New
Peril &Prize Approach

1) Make money
whichever way the
Market moves.
Peril &Prize
1) B Group more
1) Risk free
promising as still
game.
in weekly settlement
45
forward transactions.
2) If Future Contract
more or less than Fair price
2) Cash &Carry
arbitrage continues
Fair Price = Cash Price + Cost of Carry.
Example:
Current market price of ONGC in BSE= 500
Current market price of ONGC in NSE= 510
Thus the Arbitrageur earns the profit of Rs.1000(10*100)
STRATEGIES:
BUY SPOT, SELL FUTURES:

In this the investor observing that futures have been overpriced, how can the investor
cash in this opportunity to earn risk less profits. Say for instance ACC = 1000 and One month
ACC futures = 1025.
This shows that futures have been overpriced and therefore as an Arbitrageur, investor can make
risk less profits entering into the following set f transactions.
On day one, borrow funds, buy security on the spot market at 1000
Simultansely, sell the futures on the security at1025

46
Take delivery of the security purchased and hold the security for a month
on the futures expiration date, the spot and futures converge . Now unwind the position
Sa y the security closes at Rs.1015. Sell the security
Futures position expires with the profit f Rs.10
The result is a risk less profit of Rs.15 on the spot position and Rs.10 on the futures
position
Return the Borrow funds.
Finally if the cost of borrowing funds to buy the security is less than the arbitrage profit
possible, it makes sense for the investor to enter into the arbitrage. This is termed as cash andcarry arbitrage.
BUY FUTURES, SELL SPOT:
In this the investor observing that futures have been under priced, how can the
investor cash in this opportunity to earn risk less profits. Say for instance ACC = 1000 and One
month ACC futures = 965.
This shows that futures have been under priced and therefore as an Arbitrageur, investor can
make risk less profits entering into the following set f transactions.
On day one, sell the security on the spot market at 1000

Mae delivery of the security
Simultansely, buy the futures on the security at 965
On the futures expiration date, the spot and futures converge . Now unwind the position
Sa y the security closes at Rs.975. Sell the security

47
Futures position expires with the profit f Rs.10
The result is a risk less profit of Rs.25 the spot position and Rs.10 on the futures position
Finally if the returns get investing in risk less instruments is less than the return from the
arbitrage it makes sense for the investor to enter into the arbitrage. This is termed as reverse cash
andcarry arbitrage.
ARBITRAGE WITH NIFTY FUTURES:
Arbitrage is the opportunity of taking advantage of the price difference between two markets. An
arbitrageur will buy at the cheaper market and sell at the costlier market. It is possible to
arbitraged between NIFTY in the futures market and the cash market. If the futures price is any
of the prices given below other than the equilibrium price then the strategy to be followed is
CASE-1
Spot Price of INFOSEYS = 1650
Future Price Of INFOSEYS = 1675
In this case the arbitrageur will buy INFOSEYS in the cash market at Rs.1650 and sell in the
futures at Rs.1675 and finally earn risk free profit Of Rs.25.
CASE-2
Future Price Of ACC = 675
48
Spot Price of ACC = 700

In this case the arbitrageur will buy ACC in the Future market at Rs.675 and sell in the Spot at
Rs.700 and finally earn risk free profit Of Rs.25.
INTRODUCTION TO OPTIONS
It is a interesting tool for small retail investors. An option is a contract, which gives the buyer
(holder) the right, but not the obligation, to buy or sell specified quantity of the underlying
assets, at a specific (strike) price on or before a specified time (expiration date). The underlying
may be physical commodities like wheat/ rice/ cotton/ gold/ oil or financial instruments like
equity
stocks/
stock
index/
bonds
etc.
MONTHLY OPTIONS :
The exchange trade option with one month maturity and the contract usually expires on last
Thursday of every month.
PROBLEMS WITH MONTHLY OPTIONS
Investors often face a problem when hedging using the three-monthly cycle options as the
premium paid for hedging is very high. Also the trader has to pay more money to take a long or
short position which results into iiliquidity in the market.Thus to overcome the problem the BSE
introduced WEEKLY OPTIONS
WEEKLY OPTIONS:
49
The exchange trade option with one or weak maturity and the contract expires on last Friday of
every week
ADVANTAGES
Weekly Options are advantageous to many to investors, hedgers and traders.

The premium paid for buying options is also much lower as they have shorter time to
maturity.
The trader will also have to pay lesser money to take a long or short position.
the trader can take a larger position in the market with limited loss. On account of low
cost, the liquidity will improve, as more participants would come in.
Weekly Options would lead to better price discovery and improvement in market depth,
resulting in better price discovery and improvement in market efficiency
TYPES OF OPTION:
CALL OPTION
A call option gives the holder (buyer/ one who is long call), the right to buy specified quantity of
the underlying asset at the strike price on or before expiration date. The seller (one who is short
call) however, has the obligation to sell the underlying asset if the buyer of the call option
decides to exercise his option to buy. To acquire this right the buyer pays a premium to the
writer (seller) of the contract.
Example:Suppose in this option there are two parties one is Mahesh (call buyer) who is bullish in the
market and other is Rakesh (call seller) who is bearish in the market.
The current market price of RELIANCE COMPANY is Rs.600 and premium is Rs.25
1. CALL BUYER
Here the Mahesh has purchase the call option with a strike price of Rs.600.The option will be
excerised once the price went above 600. The premium paid by the buyer is Rs.25.The buyer will
earn profit once the share price crossed to Rs.625(strike price + premium). Suppose the stock has
crossed Rs.660 the option will be exercised the buyer will purchase the RELIANCE scrip from
the seller at Rs.600 and sell in the market at Rs.660.
50
Profit
30
20
10
0
590 600 610 620 630 640
-10
-20
-30
Loss
Unlimited profit for the buyer = Rs.35{(spot price strike price) premium}
Limited loss for the buyer up to the premium paid.
2. CALL SELLER:
In another scenario, if at the tie of expiry stock price falls below Rs. 600 say suppose the stock
price fall to Rs.550 the buyer will choose not to exercise the option.
Profit
30
20
10
0
590 600 610 620 630 640
-10
-20
-30
Loss
51
Profit for the Seller limited to the premium received = Rs.25

Loss unlimited for the seller if price touches above 600 say 630 then the loss of Rs.30
Finally the stock price goes to Rs.610 the buyer will not exercise the option because he has the
lost the premium of Rs.25.So he will buy the share from the seller at Rs.610.
Thus from the above example it shows that option contracts are formed so to avoid the unlimited
losses and have limited losses to the certain extent
Thus call option indicates two positions as follows:
LONG POSITION
If the investor expects price to rise i.e. bullish in the market he takes a long position by buying
call option.
SHORT POSITION
If the investor expects price to fall i.e. bearish in the market he takes a short position by selling
call option.
PUT OPTION
A Put option gives the holder (buyer/ one who is long Put), the right to sell specified
quantity of the underlying asset at the strike price on or before a expiry date. The seller of the put
option (one who is short Put) however, has the obligation to buy the underlying asset at the strike
price if the buyer decides to exercise his option to sell.
Example:Suppose in this option there are two parties one is Dinesh (put buyer) who is bearish in the
market and other is Amit(put seller) who is bullish in the market.
52
The current market price of TISCO COMPANY is Rs.800 and premium is Rs.2 0
1) PUT BUYER(Dinesh):
Here the Dinesh has purchase the put option with a strike price of Rs.800.The option will be
excerised once the price went below 800. The premium paid by the buyer is Rs.20.The buyers
breakeven point is Rs.780(Strike price Premium paid). The buyer will earn profit once the
share price crossed below to Rs.780. Suppose the stock has crossed Rs.700 the option will be
exercised the buyer will purchase the RELIANCE scrip from the market at Rs.700and sell to the
seller at Rs.800
Profit
20
10
0
600 700 800 900 1000 1100
-10
-20
Loss
Unlimited profit for the buyer = Rs.80 {(Strike price spot price) premium}
Loss limited for the buyer up to the premium paid = 20
2). PUT SELLER(Amit):
53
In another scenario, if at the time of expiry, market price of TISCO is Rs. 900. the buyer of the
Put option will choose not to exercise his option to sell as he can sell in the market at a higher
rate.
profit
20
10
0
600 700 800 900 1000 1100
-10
-20
Loss
Unlimited loses for the seller if stock price below 780 say 750 then unlimited losses for
the seller because the seller is bullish in the market = 780 - 750 = 30
Limited profit for the seller up to the premium received = 20
Thus Put option also indicates two positions as follows:
LONG POSITION
If the investor expects price to fall i.e. bearish in the market he takes a long position by buying
Put option.
SHORT POSITION
If the investor expects price to rise i.e. bullish in the market he takes a short position by selling
Put option
Option
buyer
option holder
CALL OPTIONS
PUT OPTIONS
or Buys the right to buy the Buys the right to sell the
underlying asset at the underlying asset at the
specified price
specified price
54
Option
seller
option writer
or Has the obligation to sell

the underlying asset (to the
option holder) at the
specified price
Has the obligation to buy

the underlying asset (from
the option holder) at the
specified price.
FACTORS AFFECTING OPTION PREMIUM

THE PRICE OF THE UNDERLYING ASSET: (S)
Changes in the underlying asset price can increase or decrease the premium of an option. These
price changes have opposite effects on calls and puts.

For instance, as the price of the underlying asset rises, the premium of a call will increase and the
premium of a put will decrease. A decrease in the price of the underlying assets value will
generally have the opposite effect
THE SRIKE PRICE: (K)

The strike price determines whether or not an option has any intrinsic value. An options
premium generally increases as the option gets further in the money, and decreases as the option
becomes more deeply out of the money.
Time until expiration: (t)
An expiration approaches, the level of an options time value, for puts and calls, decreases.
Volatility:
Volatility is simply a measure of risk (uncertainty), or variability of an options
underlying. Higher volatility estimates reflect greater expected fluctuations (in either direction)
in underlying price levels. This expectation generally results in higher option premiums for puts
and calls alike, and is most noticeable with at- the- money options.
Interest rate: (R1)

55
This effect reflects the COST OF CARRY the interest that might be paid for margin, in
case of an option seller or received from alternative investments in the case of an option buyer
for the premium paid.
Higher the interest rate, higher is the premium of the option as the cost of carry increases.
PLAYERS IN THE OPTION MARKET:

a) Developmental institutions
b) Mutual Funds
c) Domestic & Foreign Institutional Investors
d) Brokers
e) Retail Participants
56
57
FUTURES V/S OPTIONS

RIGHT OR OBLIGATION :
Futures are agreements/contracts to buy or sell specified quantity of the underlying assets at a
price agreed upon by the buyer & seller, on or before a specified time. Both the buyer and seller
are obligated to buy/sell the underlying asset.
In case of options the buyer enjoys the right & not the obligation, to buy or sell the underlying
asset.
RISK
Futures Contracts have symmetric risk profile for both the buyer as well as the seller.
While options have asymmetric risk profile. In case of Options, for a buyer (or holder of the
option), the downside is limited to the premium (option price) he has paid while the profits may
be unlimited. For a seller or writer of an option, however, the downside is unlimited while profits
are limited to the premium he has received from the buyer.
PRICES:
The Futures contracts prices are affected mainly by the prices of the underlying asset.
While the prices of options are however, affected by prices of the underlying asset, time
remaining for expiry of the contract & volatility of the underlying asset.
COST:
It costs nothing to enter into a futures contract whereas there is a cost of entering into an
options contract, termed as Premium.
STRIKE PRICE:
In the Futures contract the strike price moves while in the option contract the strike
price remains constant .
Liquidity:
58
As Futures contract are more popular as compared to options. Also the premium charged
is high in the options. So there is a limited Liquidity in the options as compared to Futures.
There is no dedicated trading and investors in the options contract.
Price behaviour:
The trading in future contract is one-dimensional as the price of future depends upon the price of
the underlying only. While trading in option is two-dimensional as the price of the option
depends upon the price and volatility of the underlying.
PAY OFF:
As options contract are less active as compared to futures which results into non linear
pay off. While futures are more active has linear pay off .
OPTION STRATAGIES:
1. BULL CALL SPREAD:
This strategy is used when investor is bullish in the market but to a limited upside .The Bull Call
Spread consists of the purchase of a lower strike price call an sale of a higher strike price call, of
the same month. However, the total investment is usually far less than that required to purchase
the stock.
Current price of PATNI COMPUTERS is Rs. 1500
Here the investor buys one month call of 1490 at 25 ticks per contract and sell one month call of
1510 and receive 15 ticks per contract.
Premium = 10 ticks per contract(25 paid- 15 received)
BREAK- EVEN- POINT= 1490+10=1500
Possible outcomes at expiration:

i.
BREAK- EVEN- POINT:

59
On expiration if the stock of PATNI COMPUTERS is 1500 then the option will close at
Breakeven. The call of 1490 will have an intrinsic value of 0 while the 1510 call option sold will
expire worthless and also reduce the premium received.
ii.
BETWEEN STRIKE PRICE AND BREAK- EVEN- POINT :
If the index is between1490 an 1500 then the 1490 call option will have an intrinsic value of 5
which is less than premium paid result in loss of 5.While 1510 call option sold will not expire
which will reduce the loss through receiving the net premium.
If the index is between 1500 and 1510 then the 1490 call option will have an intrinsic value of
10 i.e. deep in the money While 1510 call option sold will have no intrinsic value the premium
receive generate profit .
iii.
AT STRIKE:
If the index is at 1490, the 1490 call option will have no intrinsic value and expire worthless.
While 1510 call sold result in Rs.10 loss i.e. deep out the money.
If the index is at 1510, the 1490 call option will have an intrinsic value of 10 i.e. deep in the
money. While 1510 call sold will have no intrinsic value and expire worthless and profit is the
premium received of Rs. 10
iv.
ABOVE HIGHER PRICE:
IF the PATNI COMPUTERS is above 1510, the 1490 call option will be in the money of Rs.10
while the 1510 option i.e. strike prices-premium paid.
v.
BELOW PRICE:
IF the underlying stock is below 1490, both the 1490 call option and 1510 option sold result in
loss to the premium paid.
The pay-off table:

1485
1490
1495
PATNI
COMPUTERS
AT EXPIRATION
(below (At the (Between
1500
1510
(At BEP)
60
lower
price)
lower
price)
lower strike
&BEP
Intrinsic value of 1490 0

long call at expiration (a)
10
20
Premium paid (b)
25
25
25
25

short call at expiration
(c)
Premium received (d)
15
15
15
15
15
profit/loss(a-c)-(b- d)
-10
1495
-10
1510
-5
1505
0
1500
10
1520
25
PATNI
COMPUTERS
AT EXPIRATION
(below (At the (Between
(At BEP)
higher higher higher strike
price) price)
&BEP
(Above BEP

short call at expiration
(a)
10
Premium paid (b)
15
15
15
15

long call at expiration (c)
20
15
10
30
25
25
25
25
25
profit/loss(c-a)-( d - b)
-5
10
10
15
61
Profit
20
10
0
1490 1500 1510 1520 1530 1540
-10
-20
Loss
2. BEAR PUT SPREAD:

It is implemented in the bearish market with a limited downside. The Bear put Spread
consists of the purchase a higher strike price put and sale of a lower strike price put, of the same
month. It provides high leverage over a limited range of stock prices. However, the total
investment is usually far less than that required to buy the stock shares.
Current price of INFOSYS TECHNOLOGIES is Rs. 4500
Here the investor buys one month put of 5510(higher price) at 55 ticks per contract and sell one
month put of 4490 (lower price) and receive 45 ticks per contract.
Premium = 10 ticks per contract(55 paid- 45 received)
BREAK- EVEN- POINT= 5510-10 = 5500.
i.
BREAK- EVEN- POINT:

62
Breakeven. The put purchase of 5510 is 10 result in no-profit no loss situation to the premium
paid while the 4490 put option sold will expire worthless and also reduce the premium received.
ii.
If the index is between 5510 an 5500 then the 5510 put option will have an intrinsic value of 5
which is less than premium paid result in loss of 5.While 4490 call option sold will not expire
which will reduce the loss of Rs.10 through receiving the net premium.
If the index is between 5500 and 4490 then the 5510 put option will have an intrinsic value of 15
i.e. deep in the money While 4490 put option sold will have no intrinsic value the premium
receive will generate profit .
iii.
AT STRIKE:
If the index is at 5510, the 5510 put option will have an intrinsic value of 0 and expire
worthless. While 4490 will also have no intrinsic value an put sold result in reducing the loss as
the premium received
If the index is at 4490 the 5510 put option will have maximum profit deep in the money. While
4490 put sold will have no intrinsic value and expire worthless and profit is the premium
received between the strike price an premium paid.
iv.
ABOVE STRIKE PRICE:
IF the INFOSYS TECHNOLOGIES is above 5510, the 5510 put option will have no intrinsic
value. while the 4490 put option sold result in maximum loss to the premium received.
If the underlying stock is above 4490 but below 5510, the 4490 put option will have no intrinsic
value. while the 5510 put option sold result in the maximum profit strike price - premium
v.
BELOW STRIKE PRICE:
IF the underlying stock is below 5510, the 5510 option purchase while be in the money and
4490 option sold will be assigned (strike price premium paid) = profit .
63
The pay-off table:

5520
INFOSYS
EXPIRATION
5510
5505
5500
AT
4480
(Above (At the (Between
(At BEP)
strike) strike) lower strike
&BEP

long put at expiration (a)
10
30
Premium paid (b)
55
55
55
55

short put at expiration (c)
10
45
45
45
45
45
profit/loss(a-c)-(b- d)
-10
-10
-5
10
5505
4490
4495
5500
4480
INFOSYS
EXPIRATION
55
AT
(Above (At the (Between
(At BEP)
strike) strike) strike &BEP
(below
strike price)

short put at expiration (a)
10
Premium received (b)
45
45
45
45
45
64

long put at expiration (c)
30
15
10
30
Premium paid (d)
55
55
55
55
55
profit/loss[(c-a)-( d - b)]
-5
20
15
10
Profit
20
10
0
3000 3500 4000 4500 5000 5500 6000 6500 7000
-10
-20
Loss
3. BULL PUT SPREAD.

This strategy is opposite of Bear put spread. Here the investor is moderately bullish in the market
to provide high leverage over a limited range of stock prices. The investor buys a lower strike put
and selling a higher strike put with the same expiration dates. The strategy has both limited profit
potential
and
limited
downside
risk.
The current price of RELIANCE CAPITAL is Rs.1290

65
Here the investor buys one month put of 1300 (lower price) at 25 ticks per contract and sell
one month put of 1310 (higher price) and receive 15 ticks per contract.
Premium = 10 ticks per contract (25 paid- 15 received)
BREAK- EVEN- POINT= 1300-10 = 1290
i.
BREAK- EVEN- POINT:
On expiration if the stock of RELIANCE CAPITAL is 1290, the 1300 put option will have an
intrinsic value of 10 while the 1310 put option sold will have an intrinsic value of 30.
ii.
BETWEEN STRIKE PRICE AND BREAK- EVEN- POINT:
If the underlying index is between 1290 an 1300, the 1300 put option the buyer will have an
intrinsic value of 5 while the 1310 option sold will have an intrinsic value of 15
If the underlying index is between 1300 and 1310, the 1300 put option the buyer will have no
intrinsic value and expire worthless, while the 1310 option sold will have an intrinsic value of
5.
iii.
AT STRIKE:
If the index is at1300, the 1300 put option will have an intrinsic value of 0 and expire
worthless. While 1310 will have an intrinsic value of 10
If the index is at 1310 the 1300 put option will have an intrinsic value of 0 (deep out the money
and expire worthless. While 1310 will also have no intrinsic value and profit of seller is limited t
the premium received
iv.
ABOVE STRIKE PRICE:
If the index is above1300 say 1310, the 1300 put option buyer has lost the premium while the
1310 put option seller receive premium to the limited profit
If the index is above 1310, say 1320 the 1290 put option buyer will have maximum loss results
in deep out the money while the 1310 put option will have the limited profit.
v.
BELOW STRIKE PRICE:
66
If the index is below 1300 say (1290) , the 1300 put option buyer will have an intrinsic value
of 10 while the 1310 put option sold receive only premium as the profit is limited for the seller.
4.BEAR CALL SPREAD:

This strategy is best implemented in a moderately bearish or stable market to provide high
leverage over a limited range of stock prices. Here the investor buys a higher strike call and sells
a lower strike call with the same expiration dates. However, the total investment is usually far
less than that required to buy the stock or futures contract. The strategy has both limited profit
potential and limited downside risk.
Current price of ACC is Rs. 1500
Here the investor buys one month call of 1510 at 25 ticks per contract and sell one month call of
1490 and receive 15 ticks per contract.
Premium = 10 ticks per contract (25 paid - 15 received)
BREAK- EVEN- POINT= 1510+10=1520
i.
BREAK- EVEN- POINT:
67
Breakeven. The call of 1510 will have an intrinsic value of 10 while the 1490 call option sold
will expire worthless and also reduce the premium with the premium outflow.
ii.
If the index is between 1490 and 1500 then the 1510 call option will have no intrinsic value and
expire worthless, While 1490 call option sold will not expire which will reduce the loss through
receiving the net premium.
If the index is between 1500 and 1510 then the 1510 call option will have an intrinsic value of 0,
while 1490 call option sold will have no intrinsic value the premium receive generate profit .
iii.
AT STRIKE:
If the index is at 1510 the 1510 call option will have no intrinsic value and expire worthless.
While 1490 call sold receive only premium
If the index is at 1490, the 1510 call option will have no intrinsic value result in deep out the
money, While 1490 call sold will have no intrinsic value and expire worthless
iv.
ABOVE HIGHER PRICE :
IF the underlying stock is above 1510 say 1520, the 1510 call option will be in the money of
Rs.10 while the 1490 option will incur loss to the premium receive
IF the underlying stock is above 1490 say Below1510, the 1510 call option will not be exercised
while the 1490 option will incur loss to the premium receive because seller is bearish in the
market.
v.
BELOW STRIKE PRICE :
IF the underlying stock is below 1510, the 1510 call option will result in deep out the money
and 1490 option sold result in loss to the premium paid.
5). STRADDLE:
In this strategy the investor purchase and sell the call as well as the put option of the same strike
price, the same expiration date, and the same underlying. In this strategy the investor is neutral in
the market.
68
This strategy is often used by the SPECULATORS who believe that asset prices will move in
one direction or other significantly or will remain fairly constant.
TYPES:
LONG STRADDLE:
Here the investor takes a long position(buy) on the call and put with the same strike price and
same expiration date. In this the investor is beneficial if the price of the underlying stock move
substantially in either direction. If prices fall the put option will be profitable an if the prices rises
the call option will give gains. Profit potential in this strategy is unlimited ,While the loss is
limited up to the premium paid. This will occur if the spot price at expiration is same as the strike
price of the options.
SHORT STRADDLE:
This strategy is reverse of long straddle. Here the investor write(sell) the call as well as the put in
equal number for the same strike price an same expiration. This strategy is normally used when
the prices of the underlying stock is stable but the investor start suffering losses if the market
substantially moves in either direction .
Detailed example of a long straddle
Current market price of
BAJAJ AUTO is Rs.600
Here the investor buys one month call of strike price

month put of strike price 600 for 15 ticks per contract.
600 at 20 ticks per contract and two
Premium Paid = 35 ticks

Lower Break- Even- Point = 600 35 = 565
Higher Break- Even- Point = 600 + 35 = 635
i.
AT BREAK- EVEN- POINT:

69
If the stock is at 565 or at 635, this option strategy will be at Break- Even- Point. At 565 the 600
call will have no intrinsic value an expire worthless but the 600 put will have an intrinsic value
of 35.
At 635 the 600 call will have an intrinsic value of 35, while the put 600 will expire worthless.
ii.
BELOW STRIKE PRICE AND BELOW LOWER BEP:
If the stock price goes to 550 then the 600 call will have no intrinsic value and expire worthless
while 600 put will have an intrinsic value of 50.
iii.
ABOVE STRIKE PRICE AND ABOVE LOWER BEP:
If the stock price touches 650 the 600 call will have an intrinsic value of 50, while 600 put will
have no intrinsic value an will expire worthless.
iv.
BETWEEN LOWER BEP AND HIGHER BEP:
If the stock prices goes to 6oo then the both call and put option will expire worthless which
results in the loss of 35(premium).
The pay-off table:
550
BAJAJ AUTO
EXPIRATION
600
618
635
650
AT
(BELOW (At the (BETWEEN (At BEP)
STRIKE strike) STRIKE &
AN
D
HIGHERBEP
BELOW
BEP )
(ABOVE
STRIKE
AN
D
ABOVE
HIGHER
BEP

long call at expiration
(a)
18
35
30
Premium paid (b)
20
20
20
20

long put at expiration
(c)
10
Premium paid (d)
15
15
15
15
15
profit/loss(a+c)-(b+ d)
15
-15
-17
20
70
550
BAJAJ AUTO
EXPIRATION
600
583
565
650
AT
(BELOW (At the
STRIKE strike)
AN
D
BELOW
BEP )
(BETWEEN (At
STRIKE & LOWER
LOWER
BEP)
BEP
(ABOVE
STRIKE
AN
D
ABOVE
HIGHER
BEP

long call at expiration
(a)
30
Premium paid (b)
20
20
20
20

long put at expiration
(c)
17
35
10
Premium paid (d)
15
15
15
15
15
Profit
15
-15
-18
20
40
30
20
BEP
10
550 560 570 580 590 600 610 620 630 640
650
-10
-20
-30
-40
71
Loss
6. STRANGLE:
In this strategy the investor is neutral in the market which involves the purchase of a higher call
and a lower put that are slightly out of the money with different strike price and with the
different expiration date. The premiums are lower as compared to straddle also the risk is more
involved as compare to straddle which not leads to the profit.
TYPES
1) LONG STRANGLE:
Here the investor purchases a higher call and a lower put with different strike price and with
the different expiration date. A long strangle strategy is used to profit from a volatile price an loss
from stable prices.
2) SHORT STRANGLE:
In this the investor sells a higher call and a lower put with different strike price and with the
different expiration date. A short strangle strategy is used to profit from a stable prices an loss
starts when price is volatile.
Detailed example of a short strangle

Current market price of BSE INDEX is Rs.4000
Here the investor sells a two month call of strike price 4050 for 20 ticks per contract and two
month put of strike price 3950 for 15 ticks per contract.
72
Premium Received = 35 ticks

Lower Break- Even- Point = 3950 35 = 3915
Higher Break- Even- Point = 4050 + 35 = 4085
On Expiration:
i.
AT BREAK EVEN POINT:
If the stock is at 3915 or at 4085, this option strategy will be at Break- Even- Point. At 3915 the
4050 call will have no intrinsic value and expire worthless but the 3950 put will have an
intrinsic value of 35
At 4085 the 4050 call will have an intrinsic value of 35, while the put 400 will have no intrinsic
value and expire worthless.
ii.
BELOW STRIKE PRICE AND BELOW LOWER BEP:
If the stock price goes to 3900 then the 4050 call will have no intrinsic value and expire
worthless while 3950 put will have an intrinsic value of 50.
iii.
ABOVE STRIKE PRICE AND ABOVE LOWER BEP:
If the stock price touches 4100 the 4050 call will have an intrinsic value of 50, while 3950 put
will have no intrinsic value and will expire worthless.
iv.
BETWEEN LOWER BEP AND HIGHER BEP:
If the stock prices goes to 4000 then the both call and put option will expire worthless and
limited profit up to the premium received.
v.
AT STRIKE PRICE:
If the price is settled at 4050 then 4050 call and 3950 put will have limited profit upto the
premium received
The pay-off table:
3900
BSE
INDEX
4050
4070
4085
4100
AT
73
EXPIRATION
(BELOW (At the

STRIKE strike)
AN
D
BELOW
BEP )
(BETWEEN (At
STRIKE & HIGHER
HIGHER
BEP)
BEP)
(ABOVE
STRIKE
AN
D
ABOVE
HIGHER
BEP

Short call at expiration
(a)
20
35
50
Premium Receive(b)
20
20
20
20

short put at expiration
(c)
Premium Receive (d)
15
15
15
15
15
15
-35
-15
15
3900
3950
BSE
INDEX
EXPIRATION
20
3930
3915
AT
(BELOW (At the
STRIKE strike)
AN
D
BELOW
BEP )
(BETWEEN (At
STRIKE & LOWER
LOWER
BEP)
BEP
(ABOVE
LOWER
STRIKE
AN
D
ABOVE
LOWER
BEP

Short call at expiration
(a)
Premium Receive(b)
20
20
20
20

short put at expiration
(c)
20
35
Premium Receive (d)
15
15
15
15
20
15
74
15
-35
-15
-35
Profit
20
10
0
3900 3925 3950 3975 4000 4025 4050 4075 4100
-10
-20
Break Even - Point
Loss
7) COVERED CALL:
Under this strategy investors buys the shares which shows that they are bullish in the market
but suddenly they are scared about the market falls thus they sells the call option. Here the seller
is usually negative or neutral on the direction of the underlying security. This strategy is best
implemented in a bullish to neutral market where a slow rise in the market price of the
underlying stock is anticipated.
Thus if price rises he will not participate in the rally. However he has now reduced loss by the
amount of premium received, if prices falls.Finally if prices remains unchanged obtains the
maximum profit potential.
EXAMPLE:
Portfolio: 100 shares purchased at Rs.300
Components: Sell a two month Reliance call of 300 strike at 25
Net premium: 25 ticks
Premium received: Rs.2500 (25*100, the multiplier)
Break-even-point: Rs.275:Rs.300-25 (Premium received)
75
If the stock closes at 300, the 300 call option will not exercised and seller will receive the
premium.
If the stock ends at 275, the 300 call option expires worthless equilant to the premium received
results into no profit no loss.
If the stock ends above 300, the 300 call option is exercised and call writer receives the
premium results into the maximum profit potential.
8) COVERED PUT:
Here the writer sell stock as well as put because he overall moderate bearish on the market
and profit potential is limited to the premium received plus the difference between the original
share price of the short position and strike price of the put. The potential loss on this position,
however is substantial if price increases above the original share price of the short position. In
this case the short stock will suffer losses which will be offset by the premium received.
9) UNCOVERED CALL:
This strategy is reverse of the covered call. There is no opposite position in the naked call. A call
option writer (seller) is uncovered if the shares of the underlying security represented by the
option is not owned by the option writer.
The object of an uncovered call writer is to realize income by writing (selling) option without
committing capital to the ownership of the underlying shares.
This shows that the seller has one sided position in the contract for this the seller must deposit
and maintain sufficient margin with the broker to assure that the stock can be purchased for
delivery if option is exercised.
RISKS INVOLVED IN WRITING UNCOVERED CALL OPTION ARE AS FOLLOWS:
If the market price of the stock rises sharply the calls could be exercised, while as far as
the obligation is concerned the seller must buy the stock more than the option strike
price, which results in a substantial loss.
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The rise of buying uncovered calls is similar to that of selling stock although, as an
option writer, the risk is cushioned somewhat by the amount of premium received.
Example:Portfolio: Write reliance call of 65 strike

Net premium: 6
Lot size: 100 shares
Market action: price settled at 55
Therefore the option will not be assigned because the seller has no stock position and price
decline has no effect on the profit of the premium received.
Suppose the price settled at Rs.75 the option assigned and the seller has to cover the position
at a net loss of Rs.400 [1000 (loss on covering call)- 600(premium income)]
Finally the loss is unlimited to the increase in the stock price and profit is limited to the
declining stable stock price.
10) PROTECTIVE PUT:
Under this strategy the investor purchases the stock along with the put option because the
investor is bearish in the market. This strategy enables the holder of the stock to gain
protection from a surprise decline in the price as well as protect unrealized profits. Till the
option expires, no matter what the price of underlying is, the option buyer will be able to sell
the stock at strike price of put option.
SCENARIO
Price of HLL: 200
Components: Buy a one-month put of strike 200
Net premium: 10 ticks per contract
Premium paid: 1000 (10*100 multiplier)
Break-even-point: 210 (Rs.200+10, Premium paid)
Here the investor pays an additional margin of Rs.10 along with the price of Rs.210
combining a share with a put option is referred as a Protective Put.
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Possible outcomes at expiration

AT BREAK-EVEN-POINT:
Previously if the price rises to 200 the investor will gain but now the investor pays an margin of
Rs.10. If price rises to Rs.210 then only the investor will gain.
BELOW STRIKE PRICE:
In case of fall in the stock price the loss is limited to Rs.18. This means that he maximum loss
that the investor would have to bear is limited to the extent of premium paid.
If the price falls at 190 the investor will sell at 200.
ABOVE STRIKE PRICE :
In case of rise in prices then the put option will expire worthless and the investor will benefit
from rise in the stock price.
Finally uncertainty is the biggest curse of the market and a protective put helps override the
uncertainty in the markets. Protective put removes the uncertainty by limiting the investor loss at
Rs.10. In this case no matter what happens to the investor is protected by the loss of Rs.10. The
put option makes the investor life by telling the investor in advance how much it stands to loss.
This is also referred to as PORTFOLIO INSURANCE because it helps the investor by insuring
the value of investment just like any other asset for which the investor would purchase insurance.
PRICING OF AN OPTION
DELTA
A measure of change in the premium of an option corresponding to a change in the price of

the underlying asset.
Delta =
Change in option premium

-------------------------------Change in underlying price
FACTORS AFFECTING DELTA OPTION:
Strike price
Risk free interest rate
Volatility
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Underlying price
Time to maturity
Example:The investor has buys the call option in the future contract for the strike price of Rs.19. The
premium charged for the strike price of 19 at 0.80 The delta for this option is 0.5.Here if the
price of the option rises to 20.A rise of 1. then the premium will increase by 0.5 x 1.00 = 0.50. The
new option premium will be 0.80 + 0.50 = Rs 1.30.
Here in the money call option will increase the delta by 1.which will make the value more and
expensive while at the money option have the delta to 0.5 and finally out the money call option
will have the delta very close to 0 as the change in underlying price is not likely to make them
valuable or cheap and reverse for the put option
Delta is positive for a bullish position (long call and short put) as the value of the position
increases with rise in the price of the underlying. Delta is negative for a bearish position (short
call and long put) as the value of the position decreases with rise in the price of the underlying.
Delta varies from 0 to 1 for call options and from 1 to 0 for put options. Some people refer to
delta as 0 to 100 numbers.
ADVANTAGE
The delta is advantageous for the option buyer because it can tell him much of an option and
accordingly buyer can expect his short term movements by the underlying stock. This can help
the option of an buyer which call/put option should be bought.
GAMMA
A measure of change in the delta that may occur corresponding to the rise or fall in the price of
the underlying asset.
Gamma = change in option delta
__________________
change in underlying price
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The gamma of an option tells you how much the delta of an option would increase or decrease
for a unit change in the price of the underlying. For example, assume the gamma of an option is
0.04 and its delta is 0.5. For a unit change in the price of the underlying, the delta of the option
would change to 0.5 + 0.04 = 0.54. The new delta of the option at changed underlying price is
0.54; so the rate of change in the premium has increased. suppose the delta changed to 0.5-0.04 =
0.46 thus the rate of premium will decreased .
In simple terms if delta is velocity, then gamma is acceleration. Delta tells you how much the
premium would change; gamma changes delta and tells you how much the next premium change
would be for a unit price change in the price of the underlying.
Gamma is positive for long positions (long call and long put) and negative for short positions
(short call and short put). Gamma does not matter much for options with long maturity. However
for options with short maturity, gamma is high and the value of the options changes very fast
with swings in the underlying prices
THETA:
A measure of change in the value of an option corresponding to its time to maturity. It is a

measure of time decay (or time shrunk). Theta is generally used to gain an idea of how time
decay is affecting your portfolio.
Change in an option premium
Theta = -------------------------------------Change in time to expiry
Theta is usually negative for an option as with a decrease in time, the option value decreases.
This is due to the fact that the uncertainty element in the price decreases.
Example:Suppose the theta of Infosys 30-day call option with a strike price of Rs3,900 is 4.5 when Infosys
is quoting at Rs3,900, volatility is 50% and the risk-free interest rate is 8%. This means that if the
price of Infosys and the other parameters like volatility remain the same and one day passes, the
value of this option would reduce by Rs.4.5.
ADVANTAGE
Theta is always positive for the seller of an option, as the value of the position of the seller increases
as the value of the option goes down with time.
DISADVANTAGE
Theta is always negative for the buyer of an option, as the value of the option goes
down each day if his view is not realized.
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In simple words theta tells how much value the option would lose after one day, with all the
other parameters remaining the same.
VEGA
The extent of extent of change that may occur in the option premium, given a change in the
volatility of the underlying instrument.
Change in an option premium
Vega = ----------------------------------------Change in volatility
Example:Suppose the Vega of an option is 0.6 and its premium is Rs15 when volatility of the
underlying is 35%. As the volatility increases to 36%, the premium of the option
would change upward to Rs15.6.
Vega is positive for a long position (long call and long put) and negative for a short position (short
call and short put).
ADVANTAGE
Simply put, for the buyer it is advantageous if the volatility increases after he has
bought the option.
DISADVANTAGE
For the seller any increase in volatility is dangerous as the probability of his option getting in the
money increases with any rise in volatility.
In simple words Vega indicates how much the option premium would change for a unit change in
annual volatility of the underlying.
DERIVATIVES PRODUCTS OFFERED BY BSE
SENSEX FUTURES
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A financial derivative product enabling the investor to buy or sell underlying sensex on a
future date at a future price decided by the market forces
First financial derivative product in India.
Useful primarily for Hedging the index based portfolios and also for expressing the views on
the market
SENSEX OPTIONS:
A financial derivative product enabling the investor to buy or sell call or put options (to
be exercised on a future date) on the underlying sensex at a premium decided by the market
forces
Useful primarily for Hedging the Sensex based portfolios and also for expressing the views
on the market.
STOCK FUTURES:
A financial derivative product enabling the investor to buy or sell underlying stock on a
future date at a price decided by the market forces
Available on ____ individual stocks approved by SEBI
Useful primarily for Hedging, Arbitrage and for expressing the views on the market.
STOCK OPTIONS:
A financial derivative product enabling the investor to buy or sell call options(to be
exercised at a future date) on the underlying stock at a premium decided by the market forces
Available on individual stocks approved by SEBI
Useful primarily for Hedging, Arbitrage and for expressing the views on the market.
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CONTRACT SPECIFICATIONS
PARTICULARS
SENSEX FUTURES AND STOCK FUTURES AND

OPTIONS
OPTIONS
Underlying Asset
Sensex
Contract Multiplier
50 times
(futures)
Contract Months
100 times the

(options)
3 nearest serial months
(futures)
1, 2 and 3 months
Corresponding stock in the

cash market
the
sensex
Stock specific E.g. market
lot of RIL is 600, Infosys
sensex is 100 & so on
1, 2 and 3 months(options)
Tick size
0.1 point
0.01*
Price Quotation
Sensex point
Rupees per share
Trading Hours
9:30a.m. to 3:30p.m.
9:30a.m. to 3:30p.m.
Settlement value
In case of sensex options In case of stock options

the closing value of the the closing value of the
sensex on the expiry day
respectative in the cash
segment of BSE
Exercise Notice Time
In case of sensex options

Specified time (exercise
session) on the last trading
day of the contract. All in
the money options would
deem to be exercised
unless
communicated
otherwise
by
the
participant.
In case of stock options

Specified time (exercise
session) on the last trading
day of the contract. All in
the money options would
deem to be exercised
unless
communicated
otherwise
by
the
participant.
Last Trading Day
Last Thursday of the

contract month. If it is a
holiday, the immediately
preceding business day
Last Thursday of the

contract month. If it is a
holiday, the immediately
preceding business day
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Final Settlement
On the last trading day, the

closing value of the
Sensex would be the final
settlement price of the
expiring
futures/option
contract.
The difference is settled in

cash on the expiration day
on the basis of the closing
value of the respectative
underlying scrip in the
cash market on the
expiration day
DERIVATIVES PRODUCTS OFFERED BY NSE
INDEX FUTURES
Index Futures are Future contracts where the underlying asset is the Index. This is of great help
when one wants to take a position on market movements. Suppose you feel that the markets are
bullish and the Sensex would cross 5,000 points. Instead of buying shares that constitute the
Index you can buy the market by taking a position on the Index future
Index futures can be used for hedging, speculating, arbitrage, cash flow management and asset
allocation. The S&P 500 futures products are the largest traded index futures product in the
world.
Both the Bombay Stock exchange (BSE) and the National Stock Exchange (NSE) have launched
index futures in June 2000
ADVANTAGES OF INDEX FUTURES
The contracts are highly liquid

Index Futures provide higher leverage than any other stocks
It requires low initial capital requirement
It has lower risk than buying and holding stocks
Settled in cash and therefore all problems related to bad delivery,
forged, fake certificates, etc can be avoided.
INDEX OPTIONS
An index option provides the buyer of the option, the right but not the obligation to buy or sell the
underlying index, at a pre-determined strike price on or before the date of expiration, depending on the
type of option.
Index option offer investors an opportunity to either capitalize on an expected market move or hedge
price risk of the physical stock holdings against adverse market moves.
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NSE introduce index option in June 2001.
FUTURES ON INDIVIDUAL SECURITIES
A futures contract is a forward contract, which is traded on an Exchange. NSE commenced

trading in futures on individual securities on November 9, 2001.
NSE defines the characteristics of the futures contract such as the underlying security, market lot,
and the maturity date of the contract. The futures contracts are available for trading from
introduction to the expiry date.
CONTRACT SPECIFICATIONS
PARTICULARS
INDEX FUTURES AND OPTIONS
Underlying
S&P CNX Nifty and CNX IT
FUTURES AND OPTIONS ON

INDIVIDUAL SECURITIES
Individual Securities, at present
53 stocks
Futures / Options on Minimum
value of Rs 2 Lakh for each
individual securities Individual
Security
Contract Size
S&P CNX Nifty Futures / Permitted

lot size 200 and multiples
S&P CNX Nifty Options there of
(minimum value Rs.2 lakh)
Strike Price Interval
S&P CNX Nifty Options Rs. 10/-2.
Options on individual Between

Rs.2.50 and Rs. 100.00
securities : depending on the price
of underlying
Trading Cycle
Maximum of three month trading

cycle- near month(one), the next
month (two)and the far month
(three). New series of contract will
be introduced on the next trading
day following expiry of near month
contract
Maximum of three month trading

cycle- near month(one), the next
month (two)and the far month
(three). New series of contract
will be introduced on the next
trading day following expiry of
near month contract.
Expiry Date
The last Thursday of the expiry

month or the Previous trading day if
the last Thursday of the month is a
trading holiday
The last Thursday of the expiry

month or the Previous trading day
if the last Thursday of the month
is a trading holiday
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Settlement Basis
Index Futures / Futures Mark to

Market and final settlement on
individual securities be settled in
cash on T+1 basis
Index Options Premium settlement
on T+1 Basis and
Final Exercise settlement on T+1
basis
Options on individual Premium

settlement on T+1 basis and
securities
option
Exercise
settlement on T+2 basis.
Settlement Price
S&P CNX Nifty Futures / Daily

settlement price will be the closing
value of the underlying index
Index Options The settlement price
shall be closing value of underlying
index
Final settlement price shall be the

closing value of the underlying
security on the last trading day
The settlement price shall be
closing on individual security
price of underlying security.
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87
OPEN INTEREST(OPTIONS)
Open Interest is a crucial measure of the derivatives market. The total number of options
contracts outstanding in the market at any given point of time. In short Sum of all positions taken
by different traders reflects the Open Interest in a contract. Opposite positions taken by a trader
in a contract reduces the open interest. However, opposing positions taken (in the same contract)
by two different traders are added to the open interest.
Assuming that the market consists of three traders only following table indicates how Open
Interest changes on different days trades in PATNI COMPUTERS with a call American option at
a strike price of Rs. 180
DAY
TRADER 1
TRADER 2
TRADER 3
1
2
3
4
LONG 1200
NO TRADE
LONG 1200
SHORT 2400
SHORT 2400
LONG 1200
NO TRADE
LONG 1200
LONG 1200
SHORT 1200
SHORT 1200
LONG 1200
OPEN
INTEREST
4800
2400
2400
0
OPEN INTEREST (FUTURES)

The total number of net outstanding futures contracts is called as open interest i.e. long minus
short contracts. A decline in open interest of the near term futures indicates a short-term
weakness whereas an increase in the open interest in the long term futures indicate that the
markets may bounce back after some time provided this trend persists for a long time
A rising open interest in an uptrend is Bullish

A declining open interest in an uptrend is Bearish
A rising open interest in a downtrend is Bearish
A declining open interest in a downtrend is Bullish
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RELIANCE ADD 5 LAKH SHARES IN THE OPEN INTEREST

This shows that total number of option contracts comprising of 5lakh shares are
outstanding in the market. There has been no square off positions(opposite positions) in the
market. Thus from the open interest we come to know long and short positions made by the
investor.
RELATIONSHIP OF OPEN INTEREST WITH MARKET VOLUMES
If open interest and market volumes increases but the market is bullish this shows that
there has been buying positions in the market, which results into the positive open
interest.
If open interest and volumes increases but the market is in the bearish phase this shows
that there has been selling positions made by the investor which results into the negative
open interest
If open interest remains constant and volumes are increasing and market is also bullish
this shows that there has been intra day trading in the market.
RELATIONSHIP OF OPEN INTEREST WITH PRICES
If both open interest and prices are increasing, this shows that the buyers have entered in
the market unfolding. Expect the uptrend to continue.
If on the other hand, open interest is increasing while prices decline, sellers are expecting
for the price rise in a technically weak market. As open interest is growing while prices
decline, buyers are obviously the more aggressive party.
In the event of open interest declining while prices are also slipping, liquidation by long
positions is the implication, therefore suggesting a technically strong market overall. In
other words, the market is strong as open interest declining suggests no new aggressive
shorts, as this would entail an increase in open interest.
89
When open interest is declining and prices are increasing, short covering is the most
likely cause suggesting that overall the market is weak - i.e. attracting new buyers would
be required for a technically strong market and consequently open interest would rise.
EXAMPLE
Suppose there are only two brokers Mr. A and Mr. B in the market. A buys and B sells contracts
on Index futures on a specific day. At the end of the day , we may say that open interest in the
market is 10 contracts and volume for the day is 10 contracts.
Now, if next day a new trader Mr. C comes from Mr. A, open interest at the endo f the 2 day of
trading remains same 10 contracts and volume for the day is again 10 contracts. Understand that
on the second day, Mr. C assumes Mr. As position on first day of trading. But for the market as a
whole, at the end of the 2nd day all only 10 contracts remain open.
COST OF CARRY
The relationship between futures and spot prices can be summarized in terms of what is know as
the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset
less the income earned on the asset.
Cost of carry gives us an idea about the demand-supply forces in the futures market. It basically
indicates the annualized interest cost which players are willing to pay (receive) for buying
(selling) a futures contract.
In the Indian markets the cost of carry marketing varies between a negative 35% per annum to a
positive 35 % per annum. It can even be higher or lower than the 35% figure but that would be
an extraordinary event. We all know that at expiry the futures price closes at the cash price of the
security or an index.
The cost-of-carry model in financial futures, thus, is
Futures price = Spot price + Carrying cost Returns (dividends, etc.)
90
RELATIONSHIP OF FUTURES PRICE WITH SPOT PRICE
FUTURES PRICE HIGHER THAN THE CASH PRICE
Here futures price exceeds the cash price which indicates that the cost of carry is negative
and the market under such circumstances is termed as a backwardation market or inverted
market.
EXAMPLE
Suppose the RELIANCE share is trading at Rs.400 in the spot market. While RELIANCE
FUTURES is trading at Rs.406.Thus in this circumstances the normal strategy followed by
investors is buy the RELIANCE in the spot market and sell in the futures. On expiry, assuming
RELIANCE closes at Rs 450, you make Rs.50 by selling the RELIANCE stock and lose Rs.44
by buying back the futures, which is Rs 6 in a month. Thus Futures prices are generally higher
than the cash prices, in an overbought market.
CASH PRICE HIGHER THAN THE FUTURES PRICE
Here cash price exceeds the futures price which indicates that the cost of carry is positive and
this market is termed as oversold market. This may be due to the fact that the market is cash
settled and not delivery settled, so the futures price is more a reflection of sentiment, rather than
that of the financing cost.
EXAMPLE
Now let us assume that the RELIANCE share is trading at Rs.406 in the spot market. While
RELIANCE FUTURES is trading at Rs.400.Thus in this circumstances the normal strategy
followed by investors is buy the RELIANCE FUTURES and sell the RELIANCE in the spot
market. So at expiry if Reliance closes at Rs 450, the investor will buy back the stock at a loss of
Rs 44 and make Rs 50 on the settlement of the futures position. This is applied when the cost of
carry is high.
Thus the arbitrageur can apply this strategy and make the profits
91
92
VOLATILITY
Volatility is one of the most important factors in an options price. It measures the amount by
which an underlying asset is expected to fluctuate in an given period time. It significantly
impacts the price of an options premium and heavily contributes to an options time value.
In basic terms, volatility is merely a term used to describe how fast a stock, future or index
changes with respect to change in the price. It can be viewed as the speed of change in the
market, although the investor may prefer to think of it is as market confusion. The more confused
a market is the better the chance an option of ending up in the money. A stable market moves
slowly. Volatility measures the speed of change in the price of the underlying instrument or the
option. Higher the volatility the more the chance an option of becoming profitable by expiration
RELATIONSHIP OF PRICE VOLATILITY WITH PREMIUM
Higher the price volatility of the underlying stock of the put option, higher would be the
premium.
Lower the price volatility of the underlying stock of the call option, lower would be the
premium.
TYPES OF VOLATILITY
HISTORICAL VOLATILITY:
This (also called statistical volatility) measures price movement in terms of past.
Historical volatility is calculated by using the standard deviation of underlying asset price
changes from close to close of trading for a given period - month, half yearly, annualized
IMPLIED VOLATILITY:
It is the option market predication of volatility of the underlying instrument over the life
of the option. It helps in determining what strategies are to be used.When implied
volatility is high, the market price of the option will be greater than their theoretical price.
Example
Stock Price: Rs 280
Strike Price: Rs 260
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Annual volatility: 50%

Days to expiry 20 days
Interest rate 12% annual
The price of the Option applying Black-Scholes Model comes to Rs 26.28. But the actual price
of that Option in the market might be (say) Rs 29.50. This means that the market is imputing
another volatility to that option going forward. Now instead of providing the volatility figure
yourself, you can provide the Option price instead. Now if the investor work backwards and find
out what is the volatility that would support the price of Rs 29.50, that volatility comes to 65 per
cent.
While the value of a call option is an increasing function of the value of its underlying, it is also
an increasing function of the volatility of its underlying. That is, the more uncertain the
underlying, the more the option is worth.
From the above scenario it is possible that the players are expecting the scrip to increase another
possibility is that the market is mis-pricing the option and could fall. It could also be possible
that the market is anticipating some development, which could push the stock higher. If you
believe that volatility would rise and the underlying then you may go in for a bull strategy or if
you are an aggressive player you could sell the option with a belief to buy them at a later date.
Most traders, however, use a general rule of thumb: Buy options in low volatility and sell options
during periods of high volatility.
If you see low implied volatilities, you should buy the At the Money (ATM) option and sell an
Out of the Money (OTM) option. You can also create a similar position using puts. In this case,
you should buy ATM and sell In the Money (ITM) put options. If you see high implied
volatilities, you should buy an In the Money (ITM) Call and sell an ATM call. You will find that
both the calls are expensive, but the ATM will be in most circumstances more expensive than the
others. Thus, by selling the ATM call, you can realize a good price.
Finally implied volatility can increase or decrease even without price changes ion the
underlying security. This is because implied volatility is the level of expected volatility i.e. it is
also based not on actual prices of the security, but expected price trends. Implied voltility also
declines, as the option gets closer to expiration, as changes in volatility become less significant
with fewer trading days
BEST STRATEGY TO BE FOLLOWED IN CASE OF IMPLIED VOLATILITY

SHORT STRADDLE:
94
These involve simultaneously selling put and call options for the same stock, same strike price
and with the same expiration date. In contrast, a short strangle involves simultaneously selling
both a put and call on the same stock and same expiration date, but with the different strike price.
EXAMPLE
Let's choose the strike price 165 in Satyam for the June contracts. Satyam is one of the most
actively traded contracts in the NSE F&O segment.
The IV for the call is 97.66 per cent and that of put is 99.40 per cent on April 25, 2005 Since the
IV is high, it is a premium-selling time. (a good time to sell calls and puts)
# On May 25, the investor `short straddle' the Satyam by selling the 165 call and put for Rs 27.
# The inflow in this strategy is Rs 54 (2X27).
# The underlying spot has been trading within a range of 157-177.
# However, the call IV has ranged from 99.40 - 63.36 and that of put has ranged from 97.6646.01
# On May 29, 2003 the IV of call and put are low, hence the investor can square off positions.
# The respective IV was 63.36 for call and 46.01 for put. The underlying Satyam was Rs 169.50.
# The call closed at Rs 11.45 and the put closed at Rs 9.50.
# Square-off position by buying call and put of the same strike. Your outflow would be 20.95
(11.45+9.50). Hence, your net profits would be Rs 33.05 (54-20.95).
Here the strategy has limited profit and unlimited losses. Here the Profit is limited to the
premiums received. Losses would be unlimited if you are wrong on the stock outlook and the
volatility outlook.
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CHAPTER 4
FINDINGS,SUGGESTIONS
AND CONCLUSION
96
FINDINGS
> The study reveals the effectiveness of risk reduction using hedging strategies. It has
found out that risk cannot be avoided. But can only be minimized.
>Through the study. it has found out that, the hedging provides
a safe position on an
underlying security. The loss gets shifted to a counter party. Thus the hedging covers the
loss and risk. Sometimes, the market performs against the expectation. This will trigger
losses. so the hedger should be a strategic and positive thinker.
>The anticipation of the hedger regarding the trend of the movement in the prices of the
underlying security plays a key role in the result of the strategy applied.
>It has been found that, all the strategies applied on historical data of the period of the
study were able to reduce the loss that rose from price risk substantially.
>If the trader is not sure about the direction of the movement of the profits of the current
position, he can counter position in the future contract and reduces the level of risks.
>The trader can effectively use the strategy for return enhancement provided he has the
correct market anticipation.
>In general, the anticipation of the strategies purely for return enhancement is a risky
affair, because, if the anticipation about the performance of the market and the underlying
goes wrong, the position taker would end up in higher losses.
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SUGGEESTIONS
If an investor wants to hedge with portfolios, it must consist of scrips from different
industries, since they are convenient and represent true nature of the securities market as
a whole.
The hedging tool to reduce the losses that may arise from the market risk. Its primary
objective is loss minimization, not profit maximization .The profit from futures or shares
will be offset from the losses from futures or shares, as the case may be. as a result, a
hedger will earn a lower return compared to that of an unhedger. But the unhedger faces a
high risk than a hedger.
The hedger will have to be a strategic thinker and also one who think positively. He
should be able to comprehend market trends and fluctuations. Otherwise, the strategies
adopted by him earn him earn losses.
The hedging tool is suitable in the short term period. They can be specifically adopted by
the investor, who are facing high risks and has sufficient liquid cash with them. Long
term investor should beware from the market, because of the volatile nature of the
market.
A lot more awareness needed about the stock market and investment pattern, both in spot
and future market. The working of BSE Training Institute and NSE Institutes are
apprehensible in this regard.
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CONCLUSION
Derivative use for hedging is only to increase due to the increased global linkages and
volatile exchange rates. Firms need to look at instituting a sound risk management system and
also need to formulate their hedging strategy that suits their specific firm
characteristics and exposures.
In India, regulation has been steadily eased and turnover and liquidity in the foreign
currency derivative markets has increased, although the use is mainly in shorter maturity
contracts of one year or less. Forward and option contracts are the more popular instruments.
Regulators had initially only allowed certain banks to deal in this market however now
corporates can also write option contracts. There are many variants of these derivatives which
investment banks across the world specialize in,and as the awareness and demand for these
variants increases, RBI would have torevise regulations.
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CHAPTER 5
BIBLIOGRAPHY
100
BIBLIOGRAPHY
BOOKS
SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT
PUNITHAVATHY PANDYAN
SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT KEVIN
DERIVATIVES AND FINANCIAL INNOVATION

THE BOMBAY STOCK EXCHAHGE PUBLICATION
FUTURES AND OPTIONS- N.D. VOHRA AND B. R. BAGRI
POTFOLIO MANAGEMENT HAND BOOK ROBORT.A.STRONG
SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT

JEFFERY.V.BAILERY
Websites
www.nseindia.com
www.bseindia.com
www.capitaline.com
www.geojit.com
www.derivativeindia.com
www.capitalmarket.com
www.indiabulls.com
101

A Study On Financial Derivative and Risk Management

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TABLE OF CONTENTS

Financial derivatives are a kind of risk management instrument. A derivative's

SCOPE OF THE STUDY

It helps the researcher to construct a diversified portfolio.

OBJECTIVE OF THE STUDY

LIMITATION OF THE STUDY

PROFILE OF THE COMPANY

ABOUT BNP PARIBAS

OVERSEAS JOINT VENTURES

OVERSEAS BUSINESS ASSOCIATION

MILESTONES BY GEOJIT BNP PARIBAS

Becomes a Public Limited Company named Geojit Securities Ltd.

Kerala State Industrial Development Corporation Ltd.(KSIDC) acquires 24 percent

Membership in National Stock Exchange (NSE).

Launch of Portfolio Management Services with SEBI registration.

Depository Participant (DP) under National Securities Depository Limited.

Membership in Bombay Stock Exchange (BSE).

1st broking firm in India to offer online trading facility.

Commences Derivative Trading with NSE.

Becomes India's first DP to launch depository transactions through Internet.

Establishes Joint Venture in the UAE to serve NRI customers.

Company renamed as Geojit Financial Services Ltd.

National launch of online futures trading in Cardamom.

Geojit Credits, a subsidiary, registers with RBI as a Non-Banking Financial Company

National launch of online futures trading in Coffee.

Charter member of the Financial Planning Standards Board of India.

Launch of Property Services division.

Launch of online trading in Currency Derivatives.

Non - Executive & Independent Chairman

Managing Director & Chief Promoter

Mr. Manoj Joshi

Non - Executive & Independent Director

Mr. Mahesh Vyas

Non - Executive & Independent Director

Mr. Rakesh Jhunjhunwala

Non - Executive Director)

Mr. Ramanathan Bupathy

Non - Executive & Independent Director

Mr. Punnoose George

Non - Executive Director

Mr. Olivier Le Grand

Non - Executive Director

Mr. Pierre Rousseau

Non - Executive Director

Mr. Satish Menon

Chief Technology Officer

National Head - Distribution

Mr. Stefan Groening

Director (Planning and Control)

Mr. Binoy .V.Samuel

Chief Financial Officer

Mrs. Jaya Jacob Alexander

Chief of Human Resources

CODE OF CONDUCT FOR THE DIRECTORS AND SENIOR OFFICERS

Directors of the Company

Our Senior Management

Members of the Board of Subsidiary Company

B. Outside directorships: It is a conflict of interest to serve as a director of any company that