SUMMER TRAINING REPORT ON Hedging of risk in equity market

Submitted in the Partial Fulfillment for the Requirement of Post Graduate Diploma in Management (PGDM)

Submitted By: Shruti Arora

Roll No.95 Batch 2011-13

Submitted To:

Mr.

Amit

Rana(Cluster

Manager) Mr. J.K Batra(DEAN JIMS

KALKAJI) Jagannath International Management School Kalkaji, New Delhi

DECLARATION

I, Miss Shruti Arora do hereby declare that the project report titled hedging using option strategies is a genuine research work undertaken by me and it has not been published anywhere earlier. Date: Place:

Shruti Arora JIMS (Kalkaji)

CONTENTS

ACKNOWLEDGEMENT
I sincerely record my appreciation to all, who have contributed in preparing this report with suggestions and critical evaluation. I am extremely thankful to all in BMA WEALTH CREATORS who have given me opportunity to do my summer internship from BMA WEALTH CREATORS and helped me out with their support as and when required by me. I am extremely thankful to Mr. Batra who zestfully monitored the growth of this project. He from time to time guided me in the right direction and took care that I had enough time to complete my project. As an amateur in this field I am indebted to those who have readily responded to my request for expert guidance. Last but not the least I would like to thanks my college staff members who have helped me out at various stages in my project by guiding me the path.

Shruti Arora (JIMS Kalkaji)

EXECUTIVE SUMMARY
This project has been great learning experience for me; at the same time it gave me enough scope to implement my analytical ability. This project as a whole can be divided into two parts:

The first part gives an insight about Derivatives and its various aspects. It is purely based on whatever I learned at BMA Wealth Creators. One can have a brief knowledge about derivatives and all its basics through the project. Other than that real servings comes when one move ahead. Some of the most interesting questions regarding derivatives have been covered.

All the topics have been covered in a very systematic way. The language has been kept simple so that even a layman could understand. All the data have been well analyzed with the help of charts and graphs.

The second part consists of data and their analysis, collected through a survey done on people. The data collected have been well organized and presented. Hope the research findings and conclusions will be of use.

COMPANY OVERVIEW:-

COMPANY PROFILE :About BMA Wealth Creators:A premier financial services organization providing individual and corporates with customized financial solutions. We work towards understanding your financial goals and risk profile. Our expertise combined with thorough understanding of the financial markets results in appropriate investment solutions for you. At Wealth Creators we realize your dreams, needs, aspirations, concerns and resources are unique. This is reflected in every move we make with and for you. We have deep appreciation for the Value of building an everlasting relationship with YOU. Our financial services corporate entities are represented by: BMA WEALTH CREATORS LTD. - which holds corporate membership in two of the premier bourses viz. National Stock Exchange Ltd and Bombay Stock Exchange Ltd. and as

Depository Participant in Central Depositories Services Ltd. (CDSL) and National Securities Depositories Ltd. (NSDL). BMA COMMODITIES PVT. LTD. Which holds corporate membership in commodities exchange NCDEX and MCX? It is also is SEBI approved AMFI registered Mutual Fund advisory and intermediary. We inherit the legacy of BMA group which has been one of the dominant entities in Ferrous and Ferro Alloy industry in India. The BMA Group has created its niche in by promoting successful ventures in the fields of coal mining, refractory, steel and Ferro alloy. The strive to achieve excellence and dynamic growth has been possible through optimum mix of technology, customer orientation, best business practices, forging alliances, high quality standards and proactive business culture. Product and Services Equities & Equity Derivatives (NSE, BSE) Commodity Futures (MCX, NCDEX) Currency Futures (MCX SX)
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Depository Services (NSDL, CDSL) Mutual Funds Insurance Life and Non Life / Group Insurance IPOs, Bonds and Corporate Fixed Deposits

Product and Services Equity Broking BMAWC, as a member of the National Stock Exchange and the Bombay Stock Exchange, offers equity trading through a network of various offices across the country. It is our objective to offer a range of services to suit the trading needs of our valued clients.. Seamless Execution BMAWC provides unmatched flexibility and the power of choice to the clients for executing trades through multiple channels, viz., through our main office or branches, at any of our franchise centers or over telephone. A client may use any of these secured channels to communicate his/her orders, and he/she would be identified by his/her account code. We have endeavored to design all our processes and systems with a client-centric focus to provide a client the convenience of transacting with us through the mode and channel of his/her preference.

Investment Research BMAWC has its own Equity Research team with rich experience in identifying and analyzing attractive investment opportunities with fundamental long-term growth potential. The team has expertise in Technical Analysis, which offers technical tips for short term and day trading. It publishes Company and Industry specific reports and also outlines the days market outlook, latest domestic and international market developments.

Derivatives Trading BMAWC provides trading facilities in Equity Derivatives at National Stock Exchange (NSE) since 2005 and over the years, been able to generate substantial revenues with rising volumes from wide scale participation of retail investors in this segment. Depository Services BMAWC is a depository participant with CDSL and NSDL. BMAWC offers a range of services including: Account opening Dematerialization of physical shares Re-materialization of electronic holding Trade Settlement ( market and off market) Pledging

Financial Products Distribution Product Basket FPD desk handles all types of primary market investments a client may require. Be it a Mutual Fund, Life Insurance, General Insurance , Bonds, Fixed Deposits of blue chip corporate or IPOs of Equities. A strong distribution channel across the country providing easy access to the clients, dispersed over several States. Mutual Funds Our team tracks the performance of Mutual Funds across the gamut of investor options and advises investors. In addition to tracking the key performing funds and analyzing the portfolios and maturity profiles of different funds, our FPD team is geared to advise investors on the available options / NFOs to best suit their investment needs. Insurance

BMAWC is a leading intermediary in the LIFE and General Insurance market licensed by Insurance Regulatory and Development Authority of India.

At BMAWC, we analyze the client's requirement and capacity to understand their risk exposure and then evaluate their insurance portfolio in terms of its adequacy to protect the same. Our focus is to develop cost effective and near foolproof insurance package for our clients. In the event of a claim, our team facilitates the process to ensure speedy settlements. BMAWC has professional relationships with major Life and Non-life insurance companies in the country and is well poised to provide its clients a comprehensive risk management strategy. (Reliance Life Insurance, Birla Sun Life Insurance, Apollo DKV Health Insurance, National Insurance Company and Reliance General Insurance are our Key Partners) Bonds

For investors who prefer risk-free returns without the tension of volatile markets, the best option is the Go Savings Bond. These bonds have sovereign guarantee and thus give safe returns. Corporate Fixed Deposits

BMA WC takes the help of its own Research Desk in order to choose and cater Fixed Deposits of blue chip corporate. IPO's

In case of IPOs of Equities, BMAWC markets almost all the major issues that hit the Indian Capital Market. Customised Services

If the client is interested in any of the above investments, we would be privileged to be of assistance to invest his / her money safely. All you have to do is to call your nearest BMAWC Office and any of our team members will get in touch with you. Competitive Strength
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Regional management (regional hub and spoke topology) for retail operation Large and diverse distribution network Strong track record of high growth and profitability Strong risk management system Well established brand Existing Business Networks

BMA WEALTH CREATORS LTD has 27 strategically located own offices in India, with its headquarters in KOLKATA and 1000 plus business outlets in all prime locations of India.

Eastern Region Kolkata Siliguri Durgapur Cuttack Jamshedpur Tamluk

Southern Region Chennai Bangalore Hyderabad Coimbatore Salem Warangal

Western Region Mumbai Pune Ahmedabad

Northern Region Delhi Kanpur Varanasi Lucknow Chandigarh

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INTRODUCTION
DERIVATIVE is a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. There are mainly three types of derivatives:-Forward, Futures and option. A forward contract is a customized contract between two entities, whereas settlement takes place on a specified date in the future at todays agreed price. A future contract is an agreement between two parties to buy or sell an asset at a certain price. Future contracts are special type of forward contracts in the sense that the former are standardized exchange traded contracts. Option are of two types: - Calls and puts option. A call option gives the buyer the right to buy a certain asset within a fixed period of time but not the obligation to buy. A put option gives the buyer the right to sell a particular asset at a fixed period of time but not an obligation to sell it. Hedging is nothing but to control or eliminate the risk to a certain extent. Derivative is an important tool to hedge the risk or position by of future & option market Equity represents ownership in a company to the extent of stock held by an investor. Risks associated- investment in stock exposes to various risks such as market risk, management risk, business risk etc. My entire project revolves around DERIVATIVES AS A TOOL OF HEDGING. This project has been conducted at BMA Wealth Creators, Delhi to the best of my efforts and determination.

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RESEARCH METHODOLOGY
OBJECTIVE:-

PRIMARY: 1) To understand about derivatives market. 2) To study how does a derivative hedge the risk or position. 3) To know why derivatives is considered safer than cash market.

SECONDRY: 1) To provide better advice to the clients of BMA Wealth Creators. 2) To understand the scope of derivatives in capital market RESEARCH APPROACH:

1) Study and observance.

DATA COLLECTION:

1) Primary Data:- Formal and informal discussion with company guide and clients of the company. 2) Secondary Data:- Internet,Books,Newspapers,TV Channels, News Channels. Research Problem:-

There are very few ways for hedging price risk or price volatility in equity markets and derivatives is one of them. My study is to see how derivatives are used for hedging price risk in equity market.

Limitation:1) As research required a detail information of portfolios of clients, which is very confidential for the client, a huge difficulty was faced in getting the data 2) Also the data used in the research may suffer from incorrectness.

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3) As the company guide was very busy in her exhausting work schedule, very less guidance was available.

Scope of study: As derivatives are a very vast subject the scope of study is limited to the financial derivatives viz. futures and options. Forwards has been kept out of scope of this research. Since options are widely used for hedging, only the options cases have been taken into consideration in my research.

Sample Size: 11

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DERIVATIVES

A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.

MEANING OF DERIVATIVES

Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region. Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros. Derivatives Market is the market where the financial instrument like derivatives are traded. Primarily, Derivatives Market has been divided in two parts: Over-the-counter (OTC) Market and Exchange-traded Market where derivatives like Forwards, Futures, Swaps and Options are traded. Normally, these derivatives are tool to manage risk attached to asset, but one needs to have lot of expertise to use them in their trading strategy due to their complexity.

USE OF DERIVATIVES-

Derivatives are used by investors for the following:

provide leverage (or gearing), such that a small movement in the underlying value can cause a large difference in the value of the derivative;

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speculate and make a profit if the value of the underlying asset moves the way they expect (e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level); hedge or mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out; obtain exposure to the underlying where it is not possible to trade in the underlying (e.g., weather derivatives); create option ability where the value of the derivative is linked to a specific condition or event (e.g. the underlying reaching a specific price level).

Derivatives can be used for speculation ("bets") or to hedge ("insurance"). For example, a speculator may sell deep in-the-money naked calls on a stock, expecting the stock price to plummet, but exposing him to potentially unlimited losses. Very commonly, companies buy currency forwards in order to limit losses due to fluctuations in the exchange rate of two currencies. Third parties can use publicly available derivative prices as educated predictions of uncertain future outcomes, for example, the likelihood that a corporation will default on its debts

Some common examples of these derivatives are the following:

CONTRACT TYPES UNDERLYING Exchange-traded futures Exchange-traded options OTC swap OTC forward OTC option

Equity

Option on DJIA Index DJIA Index future future Equity swap Single-stock future Single-share option

Back-to-back Repurchase agreement

Stock option Warrant Turbo warrant

Interest rate

Eurodollar Euribor future

Option on Eurodollar future Interest future swap Option on Euribor future

rate Forward agreement

Interest rate cap and floor rate Swaption Basis swap Bond option

Credit

Bond future

Option on Bond future

Credit default Repurchase swap agreement Total return swap

Credit default option

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Foreign exchange

Currency future

Option future

on

currency

Currency swap

Currency forward

Currency option

Commodity

WTI crude oil futures

Weather derivatives

Commodity swap

Iron ore contract

forward

Gold option

WHAT IS EQUITY MARKET?

The market in which shares are issued and traded, either through exchanges or over-the-counter markets. Also known as the stock market, it is one of the most vital areas of a market economy because it gives companies access to capital and investors a slice of ownership in a company with the potential to realize gains based on its future performance. This market can be split into two main sectors: the primary and secondary market. The primary market is where new issues are first offered. Any subsequent trading takes place in the secondary market.

WHAT IS HEDGING?
A hedge is an investment position intended to offset potential losses/gains that may be incurred by a companion investment. In simple language, a hedge is used to reduce any substantial losses/gains suffered by an individual or an organization. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of over-the-counter and derivative products, and futures contracts. Public futures markets were established in the 19th century to allow transparent, standardized, and efficient hedging of agricultural commodity prices; they have since expanded to include futures contracts for hedging the values of energy, precious metals, foreign currency, and interest rate fluctuations.

HEDGING IN EQUITY MARKET?

Hedging is basically done to reduce the risk of your current investment positions. Lets say you are long on a stock (ABC), now if shares of ABC drop significantly you may lose your profit or increase your losses.
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To counter that, you may buy a put option contract on ABC which allows you to sell your shares at a specified price before the contract expires. Now, if ABC drops below the contract price, you can execute your put option (contract) and sell your shares (to the option's writer) at a price higher than the market. Thus, you have the ability to lock in a guaranteed price for your asset no matter what the market price is.

Hedging a stock price:-

A stock trader believes that the stock price of Company A will rise over the next month, due to the company's new and efficient method of producing widgets. He wants to buy Company A shares to profit from their expected price increase. But Company A is part of the highly volatile widget industry. If the trader simply bought the shares based on his belief that the Company A shares were underpriced, the trade would be a speculation. Since the trader is interested in the company, rather than the industry, he wants to hedge out the industry risk by short selling an equal value (number of shares price) of the shares of Company A's direct competitor, Company B. The first day the trader's portfolio is:

Long 1,000 shares of Company A at $1 each Short 500 shares of Company B at $2 each

(Notice that the trader has sold short the same value of shares) If the trader was able to short sell an asset whose price had a mathematically defined relation with Company A's stock price (for example a put option on Company A shares), the trade might be essentially riskless. In this case, the risk would be limited to the put option's premium. On the second day, a favourable news story about the widgets industry is published and the value of all widgets stock goes up. Company A, however, because it is a stronger company, increases by 10%, while Company B increases by just 5%:

Long 1,000 shares of Company A at $1.10 each: $100 gain Short 500 shares of Company B at $2.10 each: $50 loss

(In a short position, the investor loses money when the price goes up.) The trader might regret the hedge on day two, since it reduced the profits on the Company A position. But on the third day, an unfavourable news story is published about the health effects of widgets, and all widgets stocks crash: 50% is wiped off the value of the widgets industry in the course of a few hours. Nevertheless, since Company A is the better company, it suffers less than Company B: Value of long position (Company A):

Day 1: $1,000 Day 2: $1,100

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Day 3: $550 => ($1,000 $550) = $450 loss

Value of short position (Company B):

Day 1: $1,000 Day 2: $1,050 Day 3: $525 => ($1,000 $525) = $475 profit

Without the hedge, the trader would have lost $450 (or $900 if the trader took the $1,000 he has used in short selling Company B's shares to buy Company A's shares as well). But the hedge the short sale of Company B gives a profit of $475, for a net profit of $25 during a dramatic market collapse.

ARBITRAGE:In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit at zero cost. In principle and in academic use, an arbitrage is risk-free; in common use, as in statistical arbitrage, it may refer to expected profit, though losses may occur, and in practice, there are always risks in arbitrage, some minor (such as fluctuation of prices decreasing profit margins), some major (such as devaluation of a currency or derivative). In academic use, an arbitrage involves taking advantage of differences in price of a single asset or identical cash-flows; in common use, it is also used to refer to differences between similar assets (relative value or convergence trades), as in merger. People who engage in arbitrage are called arbitrageurs such as a bank or brokerage firm. The term is mainly applied to trading in financial instruments, such as bonds, stocks, derivatives, commodities and currencies.

CONDITIONS OF ARBITRAGE:Arbitrage is possible when one of three conditions is met: 1. The same asset does not trade at the same price on all markets ("the law of one price"). 2. Two assets with identical cash flows do not trade at the same price. 3. An asset with a known price in the future does not today trade at its future price discounted at the risk-free interest rate (or, the asset does not have negligible costs of storage; as such, for example, this condition holds for grain but not for securities).

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Arbitrage is not simply the act of buying a product in one market and selling it in another for a higher price at some later time. The transactions must occur simultaneously to avoid exposure to market risk, or the risk that prices may change on one market before both transactions are complete. In practical terms, this is generally possible only with securities and financial products that can be traded electronically, and even then, when each leg of the trade is executed the prices in the market may have moved. Missing one of the legs of the trade (and subsequently having to trade it soon after at a lower price) is called 'execution risk' or more specifically 'leg risk'. In the simplest example, any good sold in one market should sell for the same price in another. Traders may, for example, find that the price of wheat is lower in agricultural regions than in cities, purchase the good, and transport it to another region to sell at a higher price. This type of price arbitrage is the most common, but this simple example ignores the cost of transport, storage, risk, and other factors. "True" arbitrage requires that there be no market risk involved. Where securities are traded on more than one exchange, arbitrage occurs by simultaneously buying in one and selling on the other.

SPECULATION:Speculation is a financial action that does not promise safety of capital investment along with the return on the principal sum. A person or entity that engages in speculation is known as a speculator or plunger. In the capital markets, speculation refers to the buying, holding, and selling of securities to profit from fluctuations in price, as opposed to buying these instruments for use or for income via methods such as dividends or interest. Speculators play one of four primary market roles in global financial markets, distinct from hedger, arbitrageur, and investor. Speculation is typically a short-term or intermediate-term active strategy. The role of speculators in a market economy are to absorb risk and to provide liquidity in the marketplace, for the chance of monetary reward. Speculators provide trading volume and liquidity in what would otherwise be an illiquid market (thin market with a large bid-ask spread) without the presence of speculators. Speculators provide a critical and necessary role for society and the capitalist system. Speculation typically involves the lending of money (buying or selling on margin) for the purchase or sale of assets, equity or debt that is deemed to have a lower margin of safety or a significant risk of the loss of the principal investment.The term "speculation", which is formally defined as above in Graham and Dodd's 1934 text Security Analysis, contrasts with the term "investment", which is a financial operation that, upon thorough analysis, promises safety of principal and a satisfactory return. In a financial context, the terms "speculation" and "investment" are actually quite specific. For instance, although the word "investment" is commonly used to mean any act of placing money in a financial vehicle with the intent of producing returns over a period of time, most ventured moneyincluding funds placed in the world's stock marketsis technically not investment, but speculation.
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Stock speculators often react to an asset appreciating or depreciating in price due to any of a number of factors, and often enter long or short positions in hopes to profit from these price vacillations. Some such factors are shifting consumer tastes, fluctuating economic conditions, buyers' changing perceptions of the worth of a stock security, economic factors associated with market timing, the factors associated with solely chart-based analysis, and the many influences over the shortterm movement of securities. Speculators who were schooled in the trickery and mechanics of wall street have historically been referred to as wall street speculators, regardless if they were speculating at the New York Gold Exchange, the NYSE, or even on the street at the New York Curb Market (now known as NYSE Amex Equities). There are also some financial vehicles that are, by definition, speculation vehicles. For instance, trading commodity futures contracts or options contracts, such as for oil and gold, is, by definition, speculation. Short selling is also, by definition, always speculative. Financial speculation can involve the trade (buying, holding, selling) and shortselling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to attempt to profit from fluctuations in its price irrespective of its underlying value. Many speculators pay little regard to the fundamentals of a security, instead they focus purely on price movements.

FORWARD CONTRACT:-

In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price agreed upon is called the delivery price, which is equal to the forward price at the time the contract is entered into. The price of the underlying instrument, in whatever form, is paid before control of the instrument changes. This is one of the many forms of buy/sell orders where the time and date of trade is not the same as the value date where the securities themselves are exchanged.

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The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands on the spot date. The difference between the spot and the forward price is the forward premium or forward discount, generally considered in the form of a profit, or loss, by the purchasing party. Forwards, like other derivative securities, can be used to hedge risk (typically currency or exchange rate risk), as a means of speculation, or to allow a party to take advantage of a quality of the underlying instrument which is time-sensitive. A closely related contract is a futures contract; they differ in certain respects. Forward contracts are very similar to futures contracts, except they are not exchange-traded, or defined on standardized assets. Forwards also typically have no interim partial settlements or "true-ups" in margin requirements like futures such that the parties do not exchange additional property securing the party at gain and the entire unrealized gain or loss builds up while the contract is open. However, being traded over the counter (OTC), forward contracts specification can be customized and may include mark-to-market and daily margining. Hence, a forward contract arrangement might call for the loss party to pledge collateral or additional collateral to better secure the party at gain.

FUTURE CONTRACT:In finance, a futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed today (the futures price or strike) with delivery and payment occurring at a specified future date, the delivery date. The contracts are negotiated at a futures exchange, which acts as an intermediary between the two parties. The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, is said to be "long", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be "short". The terminology reflects the expectations of the partiesthe buyer hopes or expects that the asset price is going to increase, while the seller hopes or expects that it will decrease in near future. In many cases, the underlying asset to a futures contract may not be traditional commodities at all that is, for financial futures the underlying asset or item can be currencies, securities or financial and intangible assets or referenced items such as stock indexes and interest rates. While the futures contract specifies a trade taking place in the future, the purpose of the futures exchange institution is to act as intermediary and minimize the risk of default by either party. Thus the exchange requires both parties to put up an initial amount of cash, the margin. Additionally, since the futures price will generally change daily, the difference in the prior agreed-upon price and the daily futures price is settled daily also. The exchange will draw money out of one party's margin account and put it into the other's so that each party has the appropriate daily loss or profit. If the margin account goes below a certain value, then a margin call is made
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and the account owner must replenish the margin account. This process is known as marking to market. Thus on the delivery date, the amount exchanged is not the specified price on the contract but the spot value (since any gain or loss has already been previously settled by marking to market). A closely related contract is a forward contract. A forward is like a futures in that it specifies the exchange of goods for a specified price at a specified future date. However, a forward is not traded on an exchange and thus does not have the interim partial payments due to marking to market. Nor is the contract standardized, as on the exchange. Unlike an option, both parties of a futures contract must fulfill the contract on the delivery date. The seller delivers the underlying asset to the buyer, or, if it is a cashsettled futures contract, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position can close out its contract obligations by taking the opposite position on another futures contract on the same asset and settlement date. The difference in futures prices is then a profit or loss.

SWAP:-

In finance, a swap is a derivative in which counterparties exchange cash flows of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in question can be the periodic interest (or coupon) payments associated with the bonds. Specifically, the two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are calculated.Usually at the time when the contract is initiated at least one of these series of cash flows is determined by a random or uncertain variable such as an interest rate, foreign exchange rate, equity price or commodity price. The cash flows are calculated over a notional principal amount. Contrary to a future, a forward or an option, the notional amount is usually not exchanged between counterparties. Consequently, swaps can be in cash or collateral. Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the expected direction of underlying prices. Swaps were first introduced to the public in 1981 when IBM and the World Bank entered into a swap agreement. Today, swaps are among the most heavily traded financial contracts in the world: the total amount of interest rates and currency swaps outstanding is more thn $426.7 trillion in 2009, according to International Swaps and Derivatives Association (ISDA).
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OPTIONS :In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price (the strike). The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the corresponding obligation to fulfill the transaction. The price of an option derives from the difference between the reference price and the value of the underlying asset (commonly a stock, a bond, a currency or a futures contract) plus a premium based on the time remaining until the expiration of the option. Other types of options exist, and options can in principle be created for any type of valuable asset. An option which conveys the right to buy something at a specific price is called a call; an option which conveys the right to sell something at a specific price is called a put. The reference price at which the underlying asset may be traded is called the strike price or exercise price. The process of activating an option and thereby trading the underlying asset at the agreed-upon price is referred to as exercising it. Most options have an expiration date. If the option is not exercised by the expiration date, it becomes void and worthless. In return for assuming the obligation, called writing the option, the originator of the option collects a payment, the premium, from the buyer. The writer of an option must make good on delivering (or receiving) the underlying asset or its cash equivalent, if the option is exercised. An option can usually be sold by its original buyer to another party. Many options are created in standardized form and traded on an anonymous options exchange among the general public, while other over-the-counter options are customized ad hoc to the desires of the buyer, usually by an investment bank.

CONTRACT SPECIFICATIONS:Every financial option is a contract between the two counterparties with the terms of the option specified in a term sheet. Option contracts may be quite complicated; however, at minimum, they usually contain the following specifications:

whether the option holder has the right to buy (a call option) or the right to sell (a put option) the quantity and class of the underlying asset(s) (e.g., 100 shares of XYZ Co. B stock)

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the strike price, also known as the exercise price, which is the price at which the underlying transaction will occur upon exercise the expiration date, or expiry, which is the last date the option can be exercised the settlement terms, for instance whether the writer must deliver the actual asset on exercise, or may simply tender the equivalent cash amount the terms by which the option is quoted in the market to convert the quoted price into the actual premium the total amount paid by the holder to the writer.

TYPES OF OPTIONS:The Options can be classified into following types: Exchange-traded options

Exchange-traded options (also called "listed options") are a class of exchangetraded derivatives. Exchange traded options have standardized contracts, and are settled through a clearing house with fulfillment guaranteed by the credit of the exchange. Since the contracts are standardized, accurate pricing models are often available. Exchange-traded options include:

stock options, bond options and other interest rate options stock market index options or, simply, index options and options on futures contracts

callable bull/bear contract Over-the-counter

Over-the-counter options (OTC options, also called "dealer options") are traded between two private parties, and are not listed on an exchange. The terms of an OTC option are unrestricted and may be individually tailored to meet any business need. In general, at least one of the counterparties to an OTC option is a well-capitalized institution. Option types commonly traded over the counter include: 1. interest rate options 2. currency cross rate options, and 3. Options on swaps .

Option styles
Naming conventions are used to help identify properties common to many different types of options. These include:

European option an option that may only be exercised on expiration. American option an option that may be exercised on any trading day on or before expiry.
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Bermudan option an option that may be exercised only on specified dates on or before expiration. Barrier option any option with the general characteristic that the underlying security's price must pass a certain level or "barrier" before it can be exercised. Exotic option any of a broad category of options that may include complex financial structures. Vanilla option any option that is not exotic.

BlackScholes
Following early work by Louis Bachelier and later work by Edward O. Thorp, Fischer Black and Myron Scholes made a major breakthrough by deriving a differential equation that must be satisfied by the price of any derivative dependent on a nondividend-paying stock. By employing the technique of constructing a risk neutral portfolio that replicates the returns of holding an option, Black and Scholes produced a closed-form solution for a European option's theoretical price. At the same time, the model generates hedge parameters necessary for effective risk management of option holdings. While the ideas behind the BlackScholes model were groundbreaking and eventually led to Scholes and Merton receiving the Swedish Central Bank's associated Prize for Achievement in Economics (a.k.a., the Nobel Prize in Economics), the application of the model in actual options trading is clumsy because of the assumptions of continuous (or no) dividend payment, constant volatility, and a constant interest rate. Nevertheless, the BlackScholes model is still one of the most important methods and foundations for the existing financial market in which the result is within the reasonable range.

RISKS:-

As with all securities, trading options entails the risk of the option's value changing over time. However, unlike traditional securities, the return from holding an option varies non-linearly with the value of the underlying and other factors. Therefore, the risks associated with holding options are more complicated to understand and predict. In general, the change in the value of an option can be derived from Ito's lemma as:

where the Greeks , , and are the standard hedge parameters calculated from an option valuation model, such as BlackScholes, and , and are
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unit changes in the underlying's price, the underlying's volatility and time, respectively. Thus, at any point in time, one can estimate the risk inherent in holding an option by calculating its hedge parameters and then estimating the expected change in the model inputs, , and , provided the changes in these values are small. This technique can be used effectively to understand and manage the risks associated with standard options. For instance, by offsetting a holding in an option with the quantity of shares in the underlying, a trader can form a delta neutral portfolio that is hedged from loss for small changes in the underlying's price. The corresponding price sensitivity formula for this portfolio is:

Example A call option expiring in 99 days on 100 shares of XYZ stock is struck at $50, with XYZ currently trading at $48. With future realized volatility over the life of the option estimated at 25%, the theoretical value of the option is $1.89. The hedge parameters , , , are (0.439, 0.0631, 9.6, and 0.022), respectively. Assume that on the following day, XYZ stock rises to $48.5 and volatility falls to 23.5%. We can calculate the estimated value of the call option by applying the hedge parameters to the new model inputs as:

Under this scenario, the value of the option increases by $0.0614 to $1.9514, realizing a profit of $6.14. Note that for a delta neutral portfolio, whereby the trader had also sold 44 shares of XYZ stock as a hedge, the net loss under the same scenario would be ($15.86). Pin risk A special situation called pin risk can arise when the underlying closes at or very close to the option's strike value on the last day the option is traded prior to expiration. The option writer (seller) may not know with certainty whether or not the option will actually be exercised or be allowed to expire worthless. Therefore, the option writer may end up with a large, unwanted residual position in the underlying when the markets open on the next trading day after expiration, regardless of his or her best efforts to avoid such a residual. Counterparty risk A further, often ignored, risk in derivatives such as options is counterparty risk. In an option contract this risk is that the seller won't sell or buy the underlying asset as agreed. The risk can be minimized by using a financially strong intermediary able to make good on the trade, but in a major panic or crash the number of defaults can overwhelm even the st rongest intermediaries.

TRADING:27

The most common way to trade options is via standardized options contracts that are listed by various futures and options exchanges. Listings and prices are tracked and can be looked up by ticker symbol. By publishing continuous, live markets for option prices, an exchange enables independent parties to engage in price discovery and execute transactions. As an intermediary to both sides of the transaction, the benefits the exchange provides to the transaction include:

fulfillment of the contract is backed by the credit of the exchange, which typically has the highest rating (AAA), counterparties remain anonymous, enforcement of market regulation to ensure fairness and transparency, and maintenance of orderly markets, especially during fast trading conditions.

Over-the-counter options contracts are not traded on exchanges, but instead between two independent parties. Ordinarily, at least one of the counterparties is a well-capitalized institution. By avoiding an exchange, users of OTC options can narrowly tailor the terms of the option contract to suit individual business requirements. In addition, OTC option transactions generally do not need to be advertised to the market and face little or no regulatory requirements. However, OTC counterparties must establish credit lines with each other, and conform to each others clearing and settlement procedures. With few exceptions, there are no secondary markets for employee stock options. These must either be exercised by the original grantee or allowed to expire worthless. DIFFERENCE BETWEEN CALL AND PUT OPTION:CALLS You can buy or sell a call option. When you buy a call option, you have the right, but not the obligation, to purchase the underlying security at the strike price, on or before the option's expiration date. You can simply choose to trade the option, which is likely to increase in value as the underlying stock nears or exceeds the strike price. You can also allow your option contract to expire, however, as noted, this renders it worthless and you lose your initial investment. If you choose to sell a call option, you are known as a writer. You are selling call options to a buyer who has the right to exercise his option to purchase the underlying stock. If the buyer of your call exercises his right to purchase the stock, you must buy the stock at the market price and sell it to the holder of the call option at the strike price. Puts Puts are simply the opposite of calls. If you buy a put option, you are betting that the underlying security will drop in value. When you buy a put, you have the right, but not an obligation, to sell the stock at the strike price. This can be extremely profitable.
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Consider buying a $40 put on a stock that drops to $25. One option contract gives you the right to sell 100 shares of the stock at $40 on or before the option expiration date, giving you a profit of $1,500. When you sell a put option, you want a stock's price to rise so that the buyer of the put you sold will not exercise his right to sell the stock. In this case, you would pocket the option premium. If the stock dropped and the buyer of your put exercised her option, you would have to purchase the stock at the strike price and sell it at the lower market value, setting yourself up for a loss. Examples If you purchase a call option contract at $4.00 for XYZ company with a strike price of $20 and an expiration date of January 10, you have the option to buy the stock if it hits $20 on or before January 10. If the stock rose to $25, you could buy 100 shares at $20 for $2,000 and turn around and sell the shares at the market price of $25 for a profit of $500. You could also just sell the option contract before it expires. If you purchase a put option with the same strike price and expiration date, you have the option to sell the stock if it hits $20 on or before January 10. If stock hit $15, you could sell 100 shares of the stock at $20 for a $500 profit. Clearly, buying calls is a bullish strategy, while buying puts is a bearish strategy.

OPTION TERMS:-

Dividend. A portion of profits a company or mutual fund pays to its shareholders. Employee stock purchase plan. A type of employee benefit. Participants in this type of plan are often able to purchase stock at a discounted price (usually at a 15 percent discount from the current market value). Participants don't pay taxes on the investment until they sell their stock (for a profit, they hope). Exercise. The process by which an employee purchases stock he or she has the option to purchase. Being offered an option does not require the employee to purchase the stock or exercise the option. Exercise price. The price at which a holder of stock options is able to purchase the stock. Also called the strike price. Expiration date. The date by which the owner of the option must decide whether to exercise the option and actually purchase the stock. Going public. Also called an initial public offering (IPO). A company goes public when it makes the transition from being privately held (owned by individuals and private funds such as venture capital funds), to offering its first group of stocks for sale on a common market (via a stock exchange, such as the New York Stock Exchange). At this time, the value of the company - and its employees' options often increases substantially, and the company's financial performance becomes accountable to the expectations of the entire market.

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Grant price. The market price of a stock at the time the employee is granted an option. The employee may pay less than this amount if the exercise price is at a discount from the grant price. Incentive stock option. This type of stock option meets certain requirements set up by the Internal Revenue Code. It's available only to employees of a company. With this type of option, income is reported only when the stock is sold, not when the option is received or exercised. If the stock is held long enough, the employee may report long-term capital gains instead of compensation income, which could offer a significant tax savings. IPO. An initial public offering. This is the first sale of stock of a company in a publicly traded market, via a stock exchange (such as the New York Stock Exchange). See also going public. Mature ISO stock. When purchasing incentive stock options (ISO), especially if the company is about to go public or has recently gone public, employees are commonly required to hold on to the stock (not sell their shares) for a predetermined period, often several years. When this holding period is over, the stock the employee owns is considered mature ISO stock and may be sold. The profit is then considered a capital gain as opposed to compensation income. Nonqualified stock option. With this type of stock option, which has become very popular, the employee must report income upon exercising the stock. The gain - the difference between the sale price and the purchase price - is treated as income for tax purposes. Option. The right, but not the obligation, to purchase something at a specific price at a specific time. In compensation terms, a stock option. Option agreement. A document (or series of documents) that outlines the terms of and rules pertaining to an employee's stock options. Prospectus. A document describing the financial details associated with an investment opportunity. Companies that offer stock are required to issue a prospectus. It contains background information about the company - its products and services, its financial situation, and its financial forecasts. A prospectus is designed to help an investor make educated decisions about an investment opportunity. Shareholder. Someone who owns stock (shares) in a company. These are the people to whom the company is ultimately accountable for its financial performance. Note that option holders are not in the same league as bona fide shareholders. Spread. The difference between the current market value of a stock and the strike price. Stock purchase plan. Offers made to employees allowing them to purchase a stated number of shares of stock. Strike price. The price at which a holder of stock options is able to purchase the
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stock. Also called the exercise price. Vesting. The period over which an employee has the ability to realize rights, such as stock options or employer matching contributions to retirement savings plans. For example, a retirement savings plan might have a five-year vesting schedule, where after each year of employment the employee has the right to keep an additional 20 percent of employer contributions to the account. Or, an employee might be vested in 25 percent of his or her stock options after each six months of employment. Vesting schedules vary from company to company. A stock is considered "vested" when the employee may leave the job, yet maintain ownership of the stock with no consequences. Employees of some companies may need to meet certain requirements after exercising options, such as remaining with the employer for a predetermined period, in order to keep the stock.

DIFFERENCE BETWEEN OPTION AND FUTURE:-

Comparison chart

Forward Contract
Meaning: A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time.

Futures Contract
A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. Standardized. Initial margin payment required. Quoted traded on Exchange and the

Structure:

Customized to customers need. Usually no initial payment required. Negotiated directly by the buyer and seller

Transaction method:

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Marketregulation:

Not regulated

Government regulated market Clearing House

Institutional guarantee: Risk:

The contracting parties

High counterparty risk

Low counterparty risk Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market rates with daily settlement of profits and losses. Future contracts may not necessarily mature by delivery of commodity Standardized

Guarantees:

No guranantee of settlement until the date of maturity only the forward price, based on the spot price of the underlying asset is paid

Contract Maturity:

Forward contract mostly mature by delivering the commodity

Expiry date:

Depending transaction

on

the

Method of pretermination:

Opposite contract with same or different counterparty. Counterparty risk remains while terminating with different counterparty. Depending on transaction and requirements of contracting parties. the the the

Opposite contract on the exchange.

Contract size:

Standardized

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DIFFERENCE BETWEEN FUTURE AND OPTION :-

Futures vs. Options

Derivatives are created form the underlying asset like stocks, bonds and commodities. They are known to be the most complicated instruments in the entire financial market. Some of the investors find them right instruments for risk management, which increases liquidity. However, they are extremely important and have huge effects on financial markets and the economy Derivatives are mainly of two kinds, which are futures and options. There is a marked difference between futures and options. The meaning of futures is summarized as the contract made by two different parties either to purchase or sell products at a future period where the prices are predetermined. The meaning of options is the right without the obligation to purchase and sell underlining assets. Call option stands for the right without obligation to only buy the underlining asset and the purchaser may refuse the contract prior to its maturity. Put option means the opposite of call option. The basic difference of futures and options is evident in the obligation present between buyers and sellers. In the future contract, both the parties are engaged in a contract with obligation to purchase or sell the asset at a particular price on the day of settlement. This is a risky proposition for both the parties. In case of the option contract, the buyer has the right without any obligation to purchase or sell the underlying asset. This is the peculiarity of the term option and the price is paid at a premium. With this kind of trading, the purchasers risk becomes limited to the payment of premium but the prospective profit is unlimited. Beside his commissions, the investor is able to engage in future contract without any advance expenditure. In the options case, it requires the payment of a premium to be made. This additional charge is paid to get relief from the obligations to purchase underlying assets in case of negative shift in prices of assets. The only loss would be in the shape of premium when the transaction is made though option and hence the risk remains limited within the payment of premium. The other fundamental difference between futures and options relates to the size of the stock position. Usually, the position of underlying assets is very huge for the future contracts. Naturally, the obligation to purchase or selling of this huge quantity at a specified price makes the future trading absolutely risky for the fresh investor. The difference between futures and options as financial instruments depict different profit pictures for parties. The gain in the option trading can be obtained in certain
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different manners. On the contrary, the gain in the future trading is automatically linked to the daily fluctuations in the market. This is to say that the value of profit positions for investors is dependent upon the market position at the close of the trading everyday. Therefore, every investor should have a prior knowledge of both futures and options before they enter the financial market operations. Summary 1. A future is a contract which is governed by a pre-determined price for selling and buying at a future period. In options, there is the right to sell or purchase of underlying assets without any obligation. 2. A future trading has open risk. The risk in option is limited. 3. The size of the underlying stock is usually huge in future trading. Option trading is of normal size. 4. Futures need no advance payment. Options have the advance payment system of premiums.

STRATEGIES IN OPTION:-

a) Long Call :- a long call can be ideal tool for the investor who wishes to participate profitably from a downward price move in the underlying stock b) Long put:- a long put can be ideal tool for an investor who wishes to participate profitably from a downward price move from a underlying stock c) Married Put:-an investor purchasing a put while at the same time purchasing an equivalent number of shares of the underlying stock is establishing a married put position- a hedging strategy with a name from old IRS ruling. d) Protective put:- an investor who purchases a put option while holding shares of the underlying stock from a previous purchase is employing a protective put. e) Covered call:-The covered call is a strategy in which an investor writes a cal option contract while at the same time owning an equivalent no. of shares of the underlying stock. If this stock is purchased simultaneously with writing the call contract, the strategy is commonly referred to as buy write. If the shares are already held from a previous purchase, it is commonly referred to as overwrite f) Cash secured put:-According to the terms of the put contract a put writer is obligated to purchase an equivalent number of underlying shares at the put strike price if assigned an exercise notice on the written contract. Many investors write put because they are willing to be assigned and acquire shares of the underlying stocks in exchange from the premium received from the put sales. For the discussion a put
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writer position will be considered as cash secured if he has on deposit with his brokerage firm a cash amount sufficient to cover such a purchase of all option contract. g) Bull Call Spread:- Establishing a bull call spread involves the purchase of a call option on a particular underlying stock, while simultaneously writing a call option on the same underlying stock with the same expiration month, at a higher strike price. Both the buy and sell sides of this spread are opening transactions, and are always the same number of contracts. h) Bear Put Spread: - Establishing a bear put on involves the purchase of a put option on a particular underlying stock with the same expiration month, but with a lower strike price. Both the buy and sell sides of this spread are opening transactions, and are always the same number of contracts. i) Caller:- A caller can be established by holding shares o an underlying stock purchasing a protective put and writing a covered call on that stock .The option position of this strategy are referred to as combination .Generally the call and put both out of the money when this combination is established and have the expiration month.

ANALYSIS AND INTERPRETATION

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AWARENESS OF HEDGING STRATEGIES

AMONG CLIENTS

After collecting data from clients, it reveals that clients are almost aware about Long call/put strategy, Protective strategy and married put option strategy. Number of clients can be shown about awareness of different strategy in following bar graph:-

Series 1
12 10 8 6 4 2 0 long call/put strategy protective strategy married put bear call/put covered call option spread strategy strategy strategy caller strategy Series 1

Long call/put strategy:36

long call/put strategy 100%

PROTECTIVE STRATEGY:-

PROTECTIVE STRATEGY 100%

MARRIED PUT OPTION:37

MARRIED PUT OPTION 100%

BEAR CALL/PUT OPTION STRATEGY:-

18%

BEAR CALL/PUT OPTION STRATEGY 82%

COVERED CALL STRATEGY:38

9%

COVERED CALL STRATEGY 91%

ANALYSIS AND INTERPRETATION:-

Case 1

Mr. Bhandari bought 675 shares of tisco few days before the budget @350/- per share, as general expectation from the budget was that it will be an infrastructure of development focused budget. He was also bullish on tisco. However Mr. Bhandari wanted to hedge against any downward movement of tisco in the market.

Solution-

There are following alternatives for Mr. Bhandari to hedge his position 1) Long put strategy 2) Protection put strategy 3) Bear put spread strategy Since Mr. bhandari has to protect his 675 shares of tisco so in this case, to hedge against ant downward movement of tisco,Mr. bhandari will opt protective put strategy. So he should buy 1 lot of put option of Rs. 350/- strike price Rs 10/premium at the same time.
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Now the total cost of bhandari is :Bought tisco @350/- share Cost of 1 lot of tisco put option@ Rs 10 = 236250/= 6750/_______ 243000/-

ANALYSIS

S. NO STOCK STOCK PUT PRICE 1 2 3 4 5 6 7 8 9 320 330 340 350 360 370 380 390 400 VALUE 216000 222750 229500 236250 243000 249750 256500 263250 270000

COST OF

RETURN

VAUE PREMIUM 20250 6750 13500 6750 6750 0 0 0 0 0 0 6750 6750 6750 6750 6750 6750 6750 6750 6750 6750 6750 NIL 6750 13500 20250 27000

40

30000 27000 25000 20250

20000

15000 13500 10000 6750 5000 6750 6750 6750

COST OF PREMIUM RETURN

0 370 380 390 400

INTERPRETATION1) The stock value is below Rs. 350/- in the spot market, the put option will be executed. Thus put value is arrived at as (strike price-stock price)*675. 2) If the stock price goes below Rs. 360/- loss is limit to the extent of its premium amount Rs. 10 or Rs 6750/3) If the stock price goes below 360/- loss is limit to the extent of its premium amount (Rs 10/-) or Rs 6750/4) If the stock price goes up from Rs 360/- it can fetch unlimited profit as stock price keeps going on.

CASE 2:-

Mr. Bhalgat was mildly bullish on bank of India. He already got 1900 shares of Bank of India @ Rs 110/- shares few days back. Though Mr. Bhalgat, bullish on bank of India, wanted to hedge against any downside movement of Bank of India due to budget related volatility.

SOLUTION:-

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That time bank of India was trading around Rs 120-130 range.

There are following alternatives for Mr. Bhagat to hedge his position.

a) Long put strategy b) Protection put strategy c) Bear call spread strategy

Since Mr. Bhagat is mildly bullish on BOI, he will opt Bull call spread strategy, following things might be suggested :a) Buy a July call option of Bank of India for 1 lot of strike price Rs 120/shares at premium of Rs.12/- share. b) Sell a July call option of Bank of India of Rs 140/- strike price at a premium of Rs 2/- shares

Costs:-

Buying 1 lot of call option of BOI 1900*12 (-) selling 1 lot of call option of BOI 1900*2 = 3800/______ 19000/=22800/-

Analysis:-

S.NO STOCK STOCK BOUGHT SOLD PRICE

COST OF PREMIUM

RETURN

VALUE CALL VALUE

CALL VALUE 0
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90

171000 0

19000

19000

2 3 4 5 6 7 8

100 110 120 130 140 150 160

190000 0 209000 0 228000 0 247000 190000 266000 38000 285000 57000 304000 76000

0 0 0 0 0

19000 19000 19000 19000 19000

19000 19000 NIL 19000 38000 38000 38000

190000 19000 38000 19000

INTERPRETATION:-

1) Stock price is arrived at as (stock price *1900) 2) At any price above Rs 120/- shares bought call value is arrived at as {(stock price120)*1900} 3) At any price above Rs 140/-, sold call value is arrived at as {(stock price 140)*1900} 4) Return is maximum loss Rs. 19000 and maximum profit Rs 38000/-

CASE 3:-

Mr. Sonagra is a regular mid to long term investor. In the beginning of the month of the July he had not enough money in hand to invest in shares. He was supposed to get money at the end of the month.

However he was bearish on titan. He want to buy Titan but not after few days as it could lead to loss of thousands.
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SOLUTION:-

Since Mr. sonagra has not sufficient amount to invest in shares, he will adopt only Long call strategy to hedge his position.

In such circumstances Mr. Sonagra will buy one lot(800 shares) of call option at a premium of Rs 10/- per share the strike price of which is Rs. 510/-

Cost of 1 lot of titan in call option will be 800*10 =Rs 8000/-

Analysis:-

S.NO STOCK STOCK COST OF PRICE 1 2 3 4 5 6 7 8 480 490 500 510 520 530 540 550 VALUE 384000 392000 400000 408000 416000 424000 432000 440000

VALUE OF

PREMIUM CALL OPTION 8000 8000 8000 8000 8000 8000 8000 8000 0 0 0 0 10 20 30

INTERPRETATION:-

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1) Though Mr. sonagra bought a call option of a strike price of Rs 350/- he expects that the stock will grow up 2) No matter how much stock price goes up more he can fetch profit, more he can purchase at a fixed stock price of Rs 510/3) If the stock price goes down, call option will not be executed because purchasing a lot in Rs 510/- in downward movement does not sound reasonable. 4) In the downward movement his loss will be limit to the extent of premium amount (Rs 8000). 5) While in upward movement his profit will be unlimited as the price goes up deducting(premium strike price)

CASE 4:-

Mr. Pandit was holding 550 shares of Reliance Energy Ltd. ,which he had purchased @ Rs 620.Due to market sentiments and his personal study he was bearish on REL.In the fear of losing he wanted to hedge against downfall in the prices of REL.(lot size = 550)

SOLUTION:-

There are following alternatives for Mr. Pandit to hedge his position

1) Long put strategy 2) Protection put strategy 3) Bear put spread strategy

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Since Mr. Pandit has to protect his 550 shares of REL, In such circumstance Mr. Pandit will prefer to buy 1 lot of put option at a premium of lets assume Rs 10/share, strike price of which is Rs 620.

Now the total cost of Mr. Pandit will be :-

Buying of 550 shares of REL @ Rs. 620/(550*620) (+) buying of 1 lot of put option @ Rs 10/- share (10*550)

ANALYSIS :-

S. NO STOCK STOCK BOUGHT PRICE 1 2 3 4 5 6 7 8 9 590 600 610 620 630 640 650 660 670 VALUE 324500 330000 335500 341000 346500 352000 357500 363000 368500

COST OF

RETURN

PUT VALUE PREMIUM 16500 11000 5500 0 0 0 0 0 0 5500 5500 5500 5500 5500 5500 5500 5500 5500 5500 5500 5500 5500 NIL 5500 11000 16500 22000

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18000 16000 14000 12000 11000 10000 8000 6000 4000 2000 0 640 650 660 5500 5500 5500 COST OF PREMIUM RETURN 16500

INTERPRETATION:-

1) Stock value is arrived at as (stock price * 550 shares). 2) If the stock goes below from Rs. 620/- put option is executed. The put value is arrived at as (Strike price-stock price)*550 3) If the stock price goes below from Rs. 630/- (cost price) the loss is limit to the extent of its premium means Rs.5500/4) If the stock price goes up from Rs 630/- off can fetch an unlimited profit keeps going up and put option will not be executed.

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FINDINGS :-

CASE 1:-

1) As the stock price go down value of put option increases. 2) Break Even Point (BEP) for Mr. Bhandari is Rs. 360/- share or Rs. 243000/3) Loss is limit to the extent of its premium. 4) As the stock price goes up value of put option loses its significance. 5) If the put option is not executed till its expiration period it will automatically repudiate.

CASE 2:-

1) A value of stock price goes up from strike price the bought call value and sold call value increases. 2) Rs. 120/- share or Rs. 228000/- is the Break Even Point for Mr. Bhalgat. 3) Mr. Bhalgat made limit his profit and loss by buying and selling 1 lot of call option simultaneously. 4) As the stock price goes down from its strike price the value of call option loses its significance.

CASE 3:-

1) Mr. Sonagra should be quite sure that the value of stock price will increase in coming future. 2) He will fetch profit when market will be at bullish by purchasing the shares @ Rs. 510/- share and selling it in more that Rs. 520/- in the spot market. 3) Mr. Sonagra has been given right but not obligation to buy shares @Rs. 510/share and selling it in more that Rs 520/- in spot market. 4) The value of call option become insignificant if stock price goes below from Rs 510/-

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CASE 4:-

1) As the stock price decreases the value of bought put option increases. 2) Rs. 630/- share or Rs. 346500/- is the breakeven point for Mr. Pandit. 3) As the stock price goes up from its strike price put option become insignificant. 4) Here loss is limit to the extent of its premium amount. 5) If the put option is not executed till its expiration period, it is automatically repudiated.

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SUGGESTION AND CONCLUSION

SUGGESTIONS:-

CASE 1:-

1) Mr. Bhandari should be very conscious about premium rate and expiration period before opting put option. 2) If the stock price starts to decline he should not execute his put option immediately because in any low cases he will lose Rs. 6750 /- while he may fetch profit in going up of stock price after downward movement.

CASE 2:-

1) Mr. Bhagat should adopt this strategy only in that case when he is quite sure that profit is not possible after a certain extent.

CASE 3:-

1) Mr. Sonagra should buy September call option instead of july call option, because during this gap stock price must go up. 2) When stock price reaches up to its highest level he should execute his call option.

50

CASE 4:-

1) Mr. Pandit should be very conscious about premium rate and expiration period of option. 2) If the stock price starts to decline, he should not execute his put option immediately, because in any low cases he will lose Rs. 5500/- while he may fetch profit in going up of stock price after downward movement.

GENERAL SUGGESTION :-

It is humbly suggested to all clients of BMA Wealth Creators that they develop their knowledge in future and option market because it is the only way to hedge the position and they should always consider the rolling settlement of period.

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CONCLUSION:-

1) 2) 3) 4) 5) 6) 7) 8) 9)

Derivative is the best tool for hedging the position. Hedging is basically done in option market. Purchaser of a call option always hope that the stock price will go up. Purchaser of the put option always hope that the stock price will go down. Strike price and Expiration period plays an important role in hedging. Fund managers use basically index option to hedge their position. Individuals use stock option to hedge their risks. Individuals use option in speculative manner. There is wide scope of derivative markets.

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BIBLIOGRAPHY:WEBSITES:www.bmawc.com www.mutualfundsindia.com www.valuesearchonline.com www.moneycontrol.com www.morningstar.com www.yahoofinance.com www.theeconomictimes.com www.rediffmoney.com www.bseindia.com www.nseindia.com www.investopedia.com

Journals and other references:Money Today The Economic Times Business Standard The Telegraph Business India Fact sheets and statements of various fund houses.

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