SUMMER TRAINING REPORT

on Growth of derivatives India infoline

Submitted in partial fulfillment of the requirements of Post Graduate Diploma in Management By Ria Arora Batch-2012-14 Roll No- FT-12-FS-416

CERTIFICATE OF SUMMER INTERNSHIP

Acknowledgement
It gives us a great pleasure and personal satisfaction in presenting this report as a part of our Grand Project on Satisfaction level of Investors with their broking firm which has helped us to understand the preferences of investors for choosing any stock broking firm.

We are indebted to many individuals who have either directly or indirectly made an important contribution in the preparation of this report.

we are also grateful to (Director Prof. Yavar Ehsan), for giving us an opportunity to experience the corporate world, and for his valuable inputs on the project.

.We are also thankful to our co guide Mr .Rajneesh Rai

We would like to thank the entire staff of IILM GSM,

We would also like to thank all the respondents, without whom the report would not have been completed.

Last but not the least We would like to place special thanks to our parents and friends for their help and support.

Contents Sr No Title Pg No

1)

Executive Summery

2)

Company profile

3)

Introduction

4)

Need of the study

5)

Literature review

6)

Objective of the study

7)

Research methodology

8)

Limitation of the project

9)

Main topic for study

1) Introduction to derivatives

2) Development of Derivatives in

India

3) Derivative Instrument

4) Derivative User

5) Types of Derivatives a. forward b. futures c. option d. swap 6) Uses of Derivatives

7) History of derivatives

8) Recent Development

9) Strategies of Derivatives a. Bull Spread b. Bear Spread c. Butterfly d. Strangle e. Straddle 10) Risk involved

11) Technical analysis

12) Summarization of derivatives Market 13) ) Bibliography

14)

Executive Summary
This report documents the work done during the summer internship at India Info line Pvt. Ltd. Under the supervision of Mr. Rajnish Rai. The Report first shall give the overview of the currency market. Further, it introduces to currency derivatives with details behind the reason of its introduction and its growth trajectory. Furthur the impact of this derivative on the currency market and vitality of the exchange system is analyzed with empirical evidences. I have tried to keep the report simple yet technically correct. I hope I succeed in my attempt. Firstly I am briefing the what is derivatives and development in Indian market. Then at the last I am giving a suggestions and the recommendations. With over 25 millions shareholders, india has the largest investors base in the world after USA and Japan. Over 7500 companies are listed on the Indian stock exchange . The Indian capital market is significant in terms of degree of development, volume of trading , transparency and its tremedous growth potential. The emergence of Derivatives market especially Futures and Options can be traced back to the willingness of the risk adverse economic agents to guard against themselves against the fluctuations in the price of Underlying asset. Derivatives, whose price is determined by the price of underlying asset, generally do not cause any fluctuations in the price of underlying asset. But impact of any change in the price of underlying asset may cause swift change in the price of Derivatives instrument. This project concerns one of the core issues in DerivativesPricing of Derivatives and impact of change in price of underlying to the price of Futures and Option through scenario analysis , valuation of Option and Futures through appropriate mathematical models and comparison of actual market price with theoretical price and exploiting arbitrage opportunities when even there are any deviations in the pricing , past trend of Options and Futures market and daily movements in Nifty Spot , Nifty Futures and Options for the past three months.

Another important issue in Derivatives is the appropriate position to choose from plethora of series of Call options and Put Options on a single day and permutations and combinations of

strategies along with various option positions can be daunting task. This project seeks to answer some of the questions regarding appropriate strategy to choose in order to maximize total payoff through technical analysis of the parameters of Option. The two major exchanges namely the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) calculated by the number of daily transactions done on the exchanges.

For example, a dollar forward is a derivative contract, which gives the buyer a right & an obligation to buy dollars at some future date. The prices of the derivatives are driven by the spot prices of these underlying assets.

However, the most important use of derivatives is in transferring market risk, called Hedging, which is a protection against losses resulting from unforeseen price or volatility changes. Thus, derivatives are a very important tool of risk management.

I had conducted this research to find out whether investing in the derivative market is beneficial or not? You will be glad to know that derivative market in India is the most booming now days. So the person who is ready to take risk and want to gain more should invest in the derivative market.

On the other hand RBI has to play an important role in derivative market .Also SEBI must encourage investment in derivative market so that the investors get the benefit out of it. Sorry to say that today even educated persons are not willing to invest in derivative market because they have the fear of high risk.

So, SEBI should take necessary steps for improvement in Derivative Market so that more investors can invest in Derivative market

SIGNIFICANCE OF THE STUDY

The present study on Derivative futures is very much appreciable on the grounds that it gives deep insights about the stock futures market. It would be essential for the perfect way of trading in stock futures. The study elucidates the role of derivative futures in Indian financial markets. Studies of this type are more useful to academicians and scholars to make further insights into the various aspects of derivative futures in similar organizations. An investor can choose the right underlying for investment, which is risk free. The study included the changes in daily price movement and buying and selling signals to the selected stocks. These helps the investor to take right decisions regarding trading in derivative stock futures.

Company Profile

REGISTERED OFFICE

SEBI REGN NO BSE (Cash & F & o) INB011097533

India Infoline Ltd. 75,Nirllon Complex, Off western Express Highway, Goregaon(E),Mumbai-400063 Tel: (022) 66609000 Fax: (022) 26850451 Emil: mail@indiainfoline.com

NSE (Cash & F&O) INB231097537 F & O INF231097537 PMS INP000000944

COMMODITIES MCX Regn No 10590 NCDEX Regn No 00378

Vision
Our vision is to be the most respected company in the financial services space. IIFL was founded in 1995 by Mr. Nirmal Jain (Chairman and Managing Director) as an independent business research and information provider. It gradually evolved into a financial services solution provider. IIFL has a network of 3000 business locations spread over more than 500 cities and towns across India. IIFL is listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange of India (NSE) for securities trading; with MCX, NCDEX and DGCX for commodities trading; and with CDSL and NSDL as depository participants. IIFL is registered as a Category I merchant banker and is a SEBI registered portfolio manager. The IIFL (India Infoline) group, comprising the holding company, India Infoline Ltd (NSE: INDIAINFO, BSE: 532636) and its subsidiaries, is one of Indias premier providers of financial services.

IIFL offers advice and execution platform for the entire range of financial services covering products ranging from Equities and derivatives, Commodities, Wealth management, Asset management, Insurance, Fixed deposits, Loans, Investment Banking, Gold bonds and other small savings instruments.

They have a presence in:

Equities: Their core offering, gives a leading market share in both retail and institutional segments. Over a million retail customers rely on their research, as do leading FIIs and MFs that invest billions. Private Wealth Management services cater to over 2500 families who have trusted them with close to Rs 25,000 crores ($ 5bn) of assets for advice. Investment Banking services are for corporates looking to raise capital. Their forte is Equity Capital Markets, where they have executed several marquee transactions. Credit & Finance focuses on secured mortgages and consumer loans. Their high quality loan book of over Rs. 6,200 crores ($ 1.2bn) is backed by strong capital adequacy of approximately 20%. IIFL Mutual Fund made an impressive beginning in FY12, with lowest charge Nifty ETF. Other products include Fixed Maturity Plans. Life Insurance, Pension and other Financial Products, on open architecture complete their product suite to help customers build a balanced portfolio.

CSR Initiatives
In line with our vision to be the most respected company in the financial services space, we recognize the importance of contributing to and sustaining social transformation. With this end in mind, setup the IIFL foundation, which will work for the support and upliftment of the underprivileged sections of society. The IIFL Foundation focuses on specific areas of need such as healthcare and education, the foundation will screen and select institutions and developmental agencies which are working in these domains and will provide necessary aid to improve the lives of the underprivileged and help them in achieving their potential. Some of the activities undertaken by the IIFL Foundation: Barsana Camp Sponsored an Eye and Dental camp, from Jan.31st to Feb. 3rd, 2012, conducted by expert Doctors and Surgeons from the Bhaktivedanta Foundation in the village of Barsana near Mathura. Pandharpur Medical Camp Sponsored the Pandharpur Medical Camp, held by the Bhaktivedanta Hospital in July 2011 at Pandharpur. Free medical treatment and food was given to approximately 60,000 pilgrims who had come to Pandharpur during Ashadi Ekadashi. The pilgrims were treated for fever, injuries, fractures, gastroenteritis, myalagia, headache, epilepsy, malaria, respiratory infections etc, during the camp. Blood Donation Drives Organise blood donation drives at camps all across India. Over 800 employees have participated in these camps so far. Adopt a Village

To expand initiatives, exploring the best ways to take education in rural and tribal areas beyond the key basics of abc. In Adopt a Village scheme hope to impart knowledge about water conservation, waste management, sanitation, corruption prevention, and many other essential fields etc are extensively used in the country. However, the commodity derivative shave been utilized in a very limited scale. Only forwards and futures trading are permitted in certain commodity items. RELIANCE is the most active future contracts on individual securities traded with 90090 contracts and RNRL is the next most active futures contracts with 63522 contracts being traded.

Recommendations/suggestions
RBI should play a greater role in supporting derivatives. Derivatives market should be developed in order to keep it at par with other derivative markets in the world. Speculation should be discouraged. There must be more derivative instruments aimed at individual investors. SEBI should conduct seminars regarding the use of derivatives to educate individual investors. After study it is clear that Derivative influence our Indian Economy up to much extent. So, SEBI should take necessary steps for improvement in Derivative Market so that more investors can invest in Derivative market. There is a need of more innovation in Derivative Market because in today scenario even educated people also fear for investing in Derivative Market Because of high risk involved in Derivatives.

Limitations of the project

1. limited time: The time available to conduct the study was only 2 months. It being a wide topic had a Limited time. 2. Limited resources: Limited resources are available to collect the information about the commodity trading. 3. Volatality: Share market is so much volatile and it is difficult to forecast any thing about it whether you trade through online or offline 4. Aspects coverage: Some of the aspects may not be covered in my study.

INTRODUCTION TO DERIVATIVES

Risk is a characteristic feature of all commodity and capital markets. Increased financial risk causes losses to an otherwise profitable organisation. This underlines the importance of risk management to hedge against uncertainty. Derivatives provide an effective solution to the problem of risk caused by uncertainty and volatility in underlying asset. Derivatives are risk management tools that help an organisation to effectively transfer risk.

Derivatives are financial instrument whose value depends on other, more basic, underlying variables. The variables underlying could be prices of traded securities and stock, prices of gold or copper or whose value is derived from the value of something else. They generally take the form of contracts under which the parties agree to payments between them based upon the value of an underlying asset or other data at a particular point in time.

Derivatives have become increasingly important in the field of finance, Options and Futures are traded actively on many exchanges, Forward contracts, Swap and different types of options are regularly traded outside exchanges by financial intuitions, banks and their corporate clients in what are termed as over-the-counter markets in other words, there is no single market place or organized exchanges.

The main types of derivatives are :Futures forwards, options and swaps.

The main use of derivatives is to reduce risk for one party while offering the potential for a high return (at increased risk) to another. The diverse range of potential underlying assets and payoff alternatives leads to a huge range of derivatives contracts available to be traded in the market.

Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) inflation derivatives or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the payoffs.

'By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives. These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it - a process that has undoubtedly improved national productivity growth and standards of living.' -- Alan Greenspan, Chairman, Board of Governors of the US Federal Reserve System.

Derivative Defined:A derivative is a product whose value is derived from the value of one or more underlying variables or assets in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. The Forwards Contracts (Regulation) Act, 1952, regulates the forward/futures contracts in commodities all over India. As per this the Forward Markets Commission (FMC) continues to have jurisdiction over commodity futures contracts. However when derivatives trading in securities was introduced in 2001, the term security in the Securities Contracts (Regulation) Act, 1956(SCRA), was amended to include derivative contracts in securities. Consequently, regulation of derivatives came under the purview of Securities Exchange Board of India (SEBI). We thus have separate regulatory authorities for securities and commodity derivative markets. Derivatives are securities under the SCRA and hence the trading of derivatives is governed by the regulatory framework under the SCRA. The Securities Contracts (Regulation) Act, 1956 defines derivative to include-A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract differences or any other form of security .A contract which derives its value from the prices, or index of prices, of underlying securities.

Development of Derivative Markets in India

Derivatives markets have been in existence in India in some form or other for a long time. In the area of commodities, the Bombay Cotton Trade Association started futures trading in 1875 and by the early 1900s India had one of the worlds largest futures industry. In 1952 the government banned cash settlement and options trading and derivatives trading shifted to informal forwards markets. In recent years, government policy has changed, allowing for an increased role for market-based pricing and less suspicion of derivatives trading. The ban on futures trading of many commodities was lifted starting in the early 2000s, and national electronic commodity exchanges were created. In the equity markets, a system of trading called badla involving some elements of forwards trading had been in existence for decades.6 However, the system led to a number of undesirable practices and it was prohibited off and on till the Securities and Derivatives.

Exchange Board of India (SEBI) banned it for good in 2001. A series of reforms of the stock market between 1993 and 1996 paved the way for the development of exchange traded equity derivatives markets in India. In 1993, the government created the NSE in collaboration with state-owned financial institutions. NSE improved the efficiency and transparency of the stock markets by offering a fully automated screen-based trading system and real-time price dissemination. In 1995, a prohibition on trading options was lifted. In 1996, the NSE sent a proposal to SEBI for listing exchange-traded derivatives. The report of the L. C. Gupta Committee, set up by SEBI, recommended a phased introduction of derivative products, and bilevel regulation (i.e., self-regulation by exchanges with SEBI providing a supervisory and advisory role). Another report, by the J. R. Varma Committee in 1998, worked out various operational details such as the margining systems. In 1999, the Securities Contracts (Regulation) Act of 1956, or SC(R)A, was amended so that derivatives could be declared securities. This allowed the regulatory framework for trading securities to be extended to derivatives. The Act considers derivatives to be legal and valid, but only if they are traded on exchanges. Finally, a 30-year ban on forward trading was also lifted in 1999.

The economic liberalization of the early nineties facilitated the introduction of derivatives based on interest rates and foreign exchange. A system of market-determined exchange rates was adopted by India in March 1993. In August 1994, the rupee was made fully convertible on current account. These reforms allowed increased integration between domestic and international markets, and created a need to manage currency risk. Figure 1 shows how the volatility of the exchange rate between the Indian Rupee and the U.S. dollar has increased since 1991. The easing of various restrictions on the free movement of interest rates resulted in the need to manage interest rate risk.

Derivatives Instruments Traded in India

In the exchange-traded market, the biggest success story has been derivatives on equity products. Index futures were introduced in June 2000, followed by index options in June 2001, and options and futures on individual securities in July 2001 and November 2001, respectively. As of 2005, the NSE trades futures and options on 118 individual stocks and 3 stock indices. All these derivative contracts are settled by cash payment and do not involve physical delivery of the underlying product (which may be costly).

Derivatives on stock indexes and individual stocks have grown rapidly since inception. In particular, single stock futures have become hugely popular, accounting for about half of NSEs traded value in October 2005. In fact, NSE has the highest volume (i.e. number of contracts traded) in the single stock futures globally, enabling it to rank 16 among world exchanges in the first half of 2005. Single stock options are less popular than futures. Index futures are increasingly popular, and accounted for close to 40% of traded value in October 2005. Figure 2 illustrates the growth in volume of futures and options on the Nifty index, and shows that index futures have grown more strongly than index options.

NSE launched interest rate futures in June 2003 but, in contrast to equity derivatives, there has been little trading in them. One problem with these instruments was faulty contract specifications, resulting in the underlying interest rate deviating erratically from the reference rate used by market participants. Institutional investors have preferred to trade in the OTC markets, where instruments such as interest rate swaps and forward rate agreements are thriving. As interest rates in India have fallen, companies have swapped their fixed rate borrowings into floating rates to reduce funding costs.10 Activity in OTC markets dwarfs that of the entire exchange-traded markets, with daily value of trading estimated to be Rs. 30 billion in 2004.

Foreign exchange derivatives are less active than interest rate derivatives in India, even though they have been around for longer. OTC instruments in currency forwards and swaps are the most popular. Importers, exporters and banks use the rupee forward market Derivatives

To hedge their foreign currency exposure. Turnover and liquidity in this market has been increasing, although trading is mainly in shorter maturity contracts of one year or less. In a currency swap, banks and corporations may swap its rupee denominated debt into another currency (typically the US dollar or Japanese yen), or vice versa. Trading in OTC currency options is still muted. There are no exchange-traded currency derivatives in India.

Exchange-traded commodity derivatives have been trading only since 2000, and the growth in this market has been uneven. The number of commodities eligible for futures trading has increased from 8 in 2000 to 80 in 2004, while the value of trading has increased almost four times in the same period. However, many contracts barely trade and, of those that are active, trading is fragmented over multiple market venues, including central and regional exchanges, brokerages, and unregulated forwards markets. Total volume of commodity derivatives is still small, less than half the size of equity derivatives.\

Derivatives Users in India

The use of derivatives varies by type of institution. Financial institutions, such as banks, have assets and liabilities of different maturities and in different currencies, and are exposed to different risks of default from their borrowers. Thus, they are likely to use derivatives on interest rates and currencies, and derivatives to manage credit risk. Nonfinancial institutions are regulated differently from financial institutions, and this affects their incentives to use derivatives. Indian insurance regulators, for example, are yet to issue guidelines relating to the use of derivatives by insurance companies.

In India, financial institutions have not been heavy users of exchange-traded derivatives so far, with their contribution to total value of NSE trades being less than 8% in October 2005. However, market insiders feel that this may be changing, as indicated by the growing share of index derivatives (which are used more by institutions than by retail investors). In contrast to the exchange-traded markets, domestic financial institutions and mutual funds have shown great interest in OTC fixed income instruments. Transactions between banks dominate the market for interest rate derivatives, while state-owned banks remain a small presence (Chitale, 2003). Corporations are active in the currency forwards and swaps markets, buying these instruments from banks.

Why do institutions not participate to a greater extent in derivatives markets? Some institutions such as banks and mutual funds are only allowed to use derivatives to hedge their existing positions in the spot market, or to rebalance their existing portfolios. Since banks have little exposure to equity markets due to banking regulations, they have little incentive to trade equity derivatives. Foreign investors must register as foreign institutional investors (FII) to trade exchange-traded derivatives, and be subject to position limits as specified by SEBI. Alternatively, they can incorporate locally as a broker-dealer. FIIs have a small but increasing presence in the equity derivatives markets. They have no incentive to trade interest rate derivatives since they have little investments in the domestic bond markets (Chitale, 2003). It is

possible that unregistered foreign investors and hedge funds trade indirectly, using a local proprietary trader as a front (Lee, 2004).

Retail investors (including small brokerages trading for themselves) are the major participants in equity derivatives, accounting for about 60% of turnover in October 2005, according to NSE. The success of single stock futures in India is unique, as this instrument has generally failed in most other countries. One reason for this success may be retail investors prior familiarity with badla trades which shared some features of derivatives trading. Another reason may be the small size of the futures contracts, compared to similar contracts in other countries. Retail investors also dominate the markets for commodity derivatives, due in part to their long-standing expertise in trading in the havala or forwards markets.

Common Derivative contract types

There are three major classes of derivatives:
Futures/Forwards, Options,

which are contracts to buy or sell an asset at a specified future date.

which are contracts that give a holder the right (but not the obligation) to buy or sell

an asset at a specified future date.

Swaps,

where the two parties agree to exchange cash flows.

Examples
Economic

derivatives that pay off according to economic reports as measured and reported by

national statistical agencies

Energy

derivatives that pay off according to a wide variety of indexed energy prices. Usually

classified as either physical or financial, where physical means the contract includes actual delivery of the underlying energy commodity (oil, gas, power, etc)
Commodities Freight

derivatives derivatives

Inflation

Insurance derivatives Weather derivatives

Credit Sports

derivatives derivatives

Property derivatives

Classification of Derivatives
Broadly derivatives can be classified in to two categories as :Commodity derivatives and financial derivatives. In case of commodity derivatives, underlying asset can be commodities like wheat, gold, silver etc., whereas in case of financial derivatives underlying assets are stocks, currencies, bonds and other interest rates bearing securities etc. Since, the scope of this case study is limited to only financial derivatives so we will confine our discussion to financial derivatives only.

Derivative

Commodity

Financial

Complex Instrument Basic instrument

Exotic, Swaptions and Leaps etc

Forward

Future

Option

Swaps

1) Forward Contract

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. Therefore, the trade date and delivery date are separated. It is used to control and hedge risk, for example currency exposure risk (e.g., forward contracts on USD or EUR) or commodity prices (e.g., forward contracts on oil).

One party agrees (obligated) to sell, the other to buy, for a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collateralized, exchange of margin will take place according to a pre-agreed rule or schedule. Otherwise no asset of any kind actually changes hands, until the maturity of the contract.

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, usually two business days). The difference between the spot and the forward price is the forward premium or forward discount.

A standardized forward contract that is traded on an exchange is called a futures contract.

Forward contract is a cash market transaction in which delivery of the instrument is deferred until the contract has been made. Although the delivery is made in the future, the price is determined on the initial trade date. One of the parties to a forward contract assumes a long position (buyer) and agrees to buy the underlying asset at a certain future date for a certain price. The other party to the contract known as seller assumes a short position and agrees to sell the asset on the same date for the same price. The specified price is referred to as the delivery price. The contract terms like delivery price and quantity are mutually agreed upon by the parties to the contract.

Example of how the payoff of a forward contract works

Suppose that Bob wants to buy a house in one year's time. At the same time, suppose that Andy

currently owns a $100,000 house that he wishes to sell in one year's time. Both parties could enter into a forward contract with each other. Suppose that they both agree on the sale price in one year's time of $104,000 (more below on why the sale price should be this amount). Andy and Bob have entered into a forward contract. Bob, because he is buying the underlying, is said to have entered a long forward contract. Conversely, Andy will have the short forward contract. At the end of one year, suppose that the current market valuation of Andy's house is $110,000. Then, because Andy is obliged to sell to Bob for only $104,000, Bob will make a profit of $6,000. To see why this is so, one need only to recognize that Bob can buy from Andy for $104,000 and immediately sell to the market for $110,000. Bob has made the difference in profit. In contrast, Andy has made a loss of $6,000.

2) Future contract
Futures contract is a standardized contract, traded on a futures exchange, between two parties to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price.

A futures contract gives the holder the obligation to buy or sell, which differs from an options contract, which gives the holder the right, but not the obligation. In other words, the owner of an options contract may exercise the contract. Both parties of a "futures contract" must fulfill the contract on the settlement date. The seller delivers the commodity to the buyer, or, if it is a cash-settled future, 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 has to offset their position by either selling a long position or buying back a short position, effectively closing out the futures position and its contract obligations.

Futures contracts, or simply futures, are exchange traded derivatives. The exchange's clearinghouse acts as counterparty on all contracts, sets margin requirements, etc.

Future markets were designed to solve the problems that exist in forward markets. But unlike forward contracts, the futures contracts ate standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, and a standard timing of such settlement. The standardized items in a futures contract are: o Quantity of the underlying o Quality of the underlying o Date and Month of Delivery o The units of Price quotations and Minimum price changes o Location of settlement

There are many different kinds of futures contracts, reflecting the many different kinds of tradable assets of which they are derivatives. For information on futures markets in specific underlying commodity markets, follow the links.

Foreign exchange market Money market Bond market Equity index market Soft Commodities market

Following are the important types of financial futures contract:-

i Stock Future or equity futures, ii Stock Index futures, iii Currency futures, and iv Interest Rate bearing securities like Bonds, T- Bill Futures.

Types of future contract

On the basis of the underlying asset they derive, the futures are divided into following types.

STOCK FUTURES

The stock futures are the futures that have the underlying asset as the individual securities. The settlement of the stock futures is of cash settlement and the settlement price of the future is the closing price of the underlying security.

INDEX FUTURES

Index futures are the futures, which have the underlying asset as an Index. The Index futures are also cash settled. The settlement price of the Index futures shall be the closing value of the underlying index on the expiry date of the contract.

COMMODITY FUTURES

In this case, the underlying asset is a commodity. It can be an agricultural commodity like wheat corn, or even a precious asset like gold, silver etc. FINANCIAL FUTURES

In this case, the underlying assets are financial instruments like money market paper, Treasury Bills, notes, bonds etc.

CURRENCY FUTURES Currency futures are those in which the underlying assets are major convertible currencies like the U.S. dollar, the Pound Sterling, the Euro and the Yen etc.

MARGINS
Margins are the deposits, which reduce counter party risk, arise in a futures contract. These margins are collected in order to eliminate the counter party risk. There are three types of margin.

INITIAL MARGINS Whenever a futures contract is signed, both buyer and seller are required to post initial margin. Both buyer and seller are required to make security deposits that are intended to guarantee that they will infact be able to fulfill their obligation. These deposits ate Initial margins and they are often referred as performance as performance margins. The amount of margin is roughly 5% to 15% of total purchase price of futures contract.

MARKING OF MARKET MARGIN The process of adjusting the equity in an investors account in order to reflect the change in t he settlement price of futures contract is known as MTM Margin.

The features of a futures contract may be specified as follows:

i) These are traded on an organised exchange like IMM, LIFFE, NSE, BSE, CBOT etc. ii) These involve standardized contract terms viz. the underlying asset, the time of maturity and the manner of maturity etc.

iii ) These are associated with a clearing house to ensure smooth functioning of the market. iv ) There are margin requirements and daily settlement to act as further safeguard. v ) These provide for supervision and monitoring of contract by a regulatory authority. vi ) Almost ninety percent future contracts are settled via cash settlement instead of actual delivery of underlying asset.

Example of a futures contract, suppose on November 2007 Ramesh holds 1000 shares of ABC Ltd. Current (spot) price of ABC Ltd shares is Rs 115 at National Stock Exchange (NSE).

Ramesh entertains the fear that the share price of ABC Ltd may fall in next two months resulting in a substantial loss to him. Ramesh decides to enter into futures market to protect his position at Rs 115 per share for delivery in January 2008. Each contract in futures market is of 100 Shares. This is an example of equity future in which Ramesh takes short position on ABC Ltd. Shares by selling 1000 shares at Rs 115 and locks into future price.

3) OPTION
In case of futures contact, both parties are under obligation to perform their respective obligations out of a contract. But an options contract, as the name suggests, is in some sense, an optional contract. An option financial instruments that convey right, but not the obligation, to buy or sell something at a stated date at a stated price.

Options contracts are of two types: A call option gives one the right to buy; a put option gives one the right to sell.

The primary types of financial options are: also be classified as OTC (Over the Counter) options and exchange traded options.

 Exchange traded options (also called "listed options") are a class of exchange traded 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: 1. stock options, 2. commodity options, 3. bond options and other interest rate options 4. index (equity) options, and 5. options on futures contracts 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 or swaptions. Employee stock options are issued by a company to its employees as compensation.

A call options 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.

For example,

Buying a call option provides the right to buy a specified quantity of a security at a set strike price at some time on or before expiration, while buying a put option provides the right to sell. Upon the option holder's choice to exercise the option, the party who sold, or wrote, the option must fulfill the terms of the contract.

The theoretical value of an option can be determined by a variety of techniques. These models, which are developed by quantitative analysts, can also predict how the value of the option will change in the face of changing conditions. Hence, the risks associated with trading and owning options can be understood and managed with some degree of precision. Microsoft stock option contract (100 shares) Price (P) = RS 53 per share Strike price (X) = Rs50 call premium (Qc) = Rs 2.50 per share or Rs 250 for the contract put premium (Qp) = Rs 1.25 per share or Rs 125 for the contract Suppose this option contract is about to expire. We want to ask ourselves: (1) will the options be exercised by the buyer at these prices? (2) what are the payoffs to the buyer/writer at these prices? First, the call option. The buyer has the right to buy the stock for 50, and it is worth 53. Will the buyer exercise the right? YES! If the price of the underlying is greater than the strike price, the call option is in the money. This means it will be exercised. The buyer's payoff is the difference between the strike price and the market value of the stock, minus what the buyer paid for the option: (Rs 53 Rs 50 Rs 2.50)(100) = Rs 50

The writer must sell the stock for less than it is worth, but received the call premium, so the writer payoff is: (Rs 50 Rs 53 + Rs 2.50)(100) = -Rs50. that the buyer's and writer's payoffs sum to zero. THIS IS ALWAYS THE CASE FOR ANY OPTIONS CONTRACT. Now the put option. The buyer has the right to SELL the stock for 50, but they can sell it elsewhere for 53. Will put buyer sell the stock. NO! If the price of the underlying is greater than the strike price, the put option isout of the money. This means it will NOT be exercised and will be allowed to expire unused. The buyer does not exercise the option, so the buyer is just out the put premium of Rs125. The writer received the put premium of 125, but does not have to do anything since the option is not used. Note that the buyer of a put or call option cannot lose more than the option premium. The buyer's losses are limited, the writer's losses are potentially huge. It is the price, P, and strike price, X, that determined if an option is in or out of the money. However, an in the money option does not guarantee a positive payoff.

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)

 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

Example Suppose an investor buys One European call options on Infosys at the strike price of Rs. 3500 at a premium of Rs. 100. Apparently, if the market price of Infosys on the day of expiry is more than Rs. 3500, the options will be exercised. In contrast, a put options 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 an expiry date. The seller of the put options (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. Right to sell is called a Put Options. Suppose X has 100 shares of Bajaj Auto Limited. Current price (March) of Bajaj auto shares is Rs 700 per share. X needs money to finance its requirements after two months which he will realize after selling 100 shares after two months. But he is of the fear that by next two months price of share will decline. He decides to enter into option market by buying Put Option (Right to Sell) with an expiration date in May at a strike price of Rs 685 per share and a premium of Rs 15 per shares.

The basic trades of traded stock options

These trades are described from the point of view of a speculator. If they are combined wit other positions, they can also be used in hedging.

Long Call

Payoffs and profits from a long call. A trader who believes that a stock's price will increase might buy the right to purchase the stock (a call option) rather than just buy the stock. He would have no obligation to buy the stock, only the right to do so until the expiration date. If the stock price increases over the exercise price by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can obtain a larger number of options than shares. If the stock rises, he will thus realize a larger gain than if he had purchased shares.

Short Call

Payoffs and profits from a naked short call. A trader who believes that a stock price will decrease, can sell the stock short or instead sell, or "write," a call. Because both strategies expose the investor to unlimited losses, they are generally considered inappropriate for small investors. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money, with the potential loss unlimited. Long put

Payoffs and profits from a long put. A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price (a put option). He will be under no obligation to sell the stock, but has the right to do so until the expiration date. If the stock price decreases below the exercise price by more than the premium paid, he will profit. If the stock price increases, he will just let the put contract expire worthless and only lose his premium paid. Short Put

Payoffs and profits from a naked short put. A trader who believes that a stock price will increase can buy the stock or instead sell a put. The trader selling a put has an obligation to buy the stock from the put buyer at the put buyer's option. If the stock price increases, the short put position will make a profit in the amount of the premium. If the stock price decreases below the exercise price by more than the amount of the premium, the trader will lose money, with the potential loss being up to the full value of the stock.

4) Swaps Contract
A swap can be defined as a barter or exchange. It is a contract whereby parties agree to exchange obligations that each of them have under their respective underlying contracts or we can say, a swap is an agreement between two or more parties to exchange stream of cash flows over a period of time in the future.

The parties that agree to the swap are known as counter parties. The two commonly used swaps are:

i) Interest rate swaps which entail swapping only the interest related cash flows between the

parties in the same currency, and

ii) Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than the cash flows in the opposite direction.

The five generic types of swaps, in order of their quantitative importance, are: interest rate swaps, currency swaps, credit swaps, commodity swaps and equity swaps.

Example of SWAP

Take the case of a plain vanilla fixed-to-floating interest rate swap. Here party A makes periodic interest payments to party B based on a variable interest rate of LIBOR +50 basis points.

Party B in turn makes periodic interest payments based on a fixed rate of 3%. The payments are calculated over the notional amount. The first rate is called variable, because it is reset at the beginning of each interest calculation period to the then current reference rate, such as LIBOR.

Other types of derivatives Freight derivative, or Forward Freight Agreement (FFA), is a financial instrument for
trading in future levels of freight rates, for dry bulk carriers and tankers. These instruments are settled against various freight rate indices published by the Baltic Exchange and Platt's. FFAs are usually traded over the counter, but screen-based trading is becoming more popular. Trades can be given up for clearing by the broker to one of the clearing houses that support such trades.

Inflation derivatives (or inflation-indexed derivatives) refer to over-the-counter and

exchange-traded derivatives that are used to transfer inflation risk from one counterparty to another. Typically, real rate swaps also come under this bracket, such as asset swaps of inflation indexed bonds.

Inflation swaps are the linear form of these derivatives. They can take a similar form to fixed versus floating interest rate swaps (which are the derivative form for fixed rate bonds), but use a real rate coupon versus floating, but also pay a redemption pickup at maturity (i.e., the derivative form of inflation indexed bonds).

Inflation swaps are typically priced on a zero-coupon basis (ZC), with payment exchanged at the end of the term. One party pays the compounded fixed and the other the actual inflation rate for the term. Inflation swaps can also be paid on a year-on-year basis (YOY) where the year onyear rate of change of the price index is paid.

Real rate swaps are the nominal interest swap rate less the corresponding inflation swap. Weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. The difference from other derivatives is that the underlying asset (rain/temperature/snow) has no direct value to price the weather derivative. Farmers can use weather derivatives to hedge against poor harvests caused by drought or frost; theme parks may want to insure against rainy weekends during peak summer seasons; and gas and power companies may use heating degree days (HDD) or cooling degree days (CDD) contracts to smooth earnings.

Heating degree days are one of the most common types of weather derivative. Typical terms for an HDD contract could be: for the November to March period, for each day where the temperature falls below 18 degrees Celsius keep a cumulative count of the difference between 18 degrees and the average daily temperature. Depending upon whether the option is a put option or a call option, pay out a set amount per heating degree day that the actual count differs from the strike. Credit derivative is a financial instrument or derivative whose price and value derives from the creditworthiness of the obligations of a third party, which is isolated and traded." Credit default products are the most commonly traded credit derivative product and include unfunded products such as credit default swaps and funded products such as synthetic CDOs

 Property derivative is a derivative (finance) whose price and value derives from the value of a real estate asset, usually represented in the form of an index. The product usually takes the form of a total return swap or forward and can adopt a funded format where the property derivative is embedded into a note structure. Under the total return swap or forward the parties will usually take contrary positions on the price movements of a property index. Commodity Derivatives Futures contracts in pepper, turmeric, gur, hessian, jute sacking, castor seed, potato, coffee, cotton, and soybean and its derivatives are traded in 18commodity exchanges located in various parts of the country. Futures trading in other Edible oils, oilseeds and oil cakes have been permitted. Trading in futures in the new commodities, especially in edible oils, is expected to commence in the near future. The sugar industry is exploring the merits of trading sugar futures contracts.

Need of the study

The study has been done to know the different types of derivatives and also to know the derivative market in India. This study also covers the recent developments in the derivative market taking into account the trading in past years. Through this study I came to know the trading done in derivatives and their use in the stock markets.
1. They help in transferring risks from risk averse people to risk oriented people 2. They help in the discovery of future as well as current prices 3. They catalyze entrepreneurial activity 4. They increase the volume traded in markets because of participation of risk averse people in greater numbers 5. They increase savings and investment in the long run .

Literature review
The emergence of the market for derivative products, most not ably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors . Derivative products initially emerged, as hedging devices against fluctuations in commodity prices and commodity-linked derivatives remained the sole form of such products for almost three hundred years. The financial derivatives came into spotlight in post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously both in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to high correlation of the popular indices with various portfolios and ease of use. The lower costs associated with index derivatives vis-vis derivative products based on individual securities is another reason for their growing use. As in the present scenario, Derivative Trading is fast gaining momentum,I have chosen this topic.

Objective of the study

To understand the concept of the Derivatives and Derivative Trading. To know different types of Financial Derivatives To know the role of derivatives trading in India. To analyse the performance of Derivatives Trading since 2001with special reference to Futures & Options.

To observe the daily price movement of selected stock futures. To identify the buying and selling signals to the selected scripts.

Scope of the project

The project covers the derivatives market and its instruments. For better understanding various strategies with different situations and actions have been given. It includes the data collected in the recent years and also the market in the derivatives in the recent years. This study extends to the trading of derivatives done in the National Stock Markets.

Research Methodology
Method of data collection:The data had been collected through Primary and Secondary sources.

Primary sources:The data had been collected through project guide and staff of the Company.

Secondary sources:It is the data which has already been collected by some one or an organization for some other purpose or research study . The data for study has been collected from various sources: Books Journals Magazines Internet sources Time: 2 months

Statistical Tools Used:

Simple tools like bar graphs, tabulation, line diagrams have been used.

CONCLUSION
Innovation of derivatives have redefined and the landscape of financial industry across the world and derivatives have earned a well deserved and extremely significant place among all the financial products. Derivatives are risk management tool that help in effective management of risk by various stakeholders. Derivatives provide an opportunity to transfer risk, from the one who wish to avoid it; to one, who wish to accept it. Indias experience with the launch of equity derivatives market has been extremely encouraging and successful. The derivatives turnover on the NSE has surpassed the equity market turnover. Significantly, its growth in the recent years has surpassed the growth of its counterpart globally. In terms of the growth of derivatives markets, and the variety of derivatives users, the Indian market has equalled or exceeded many other regional markets. While the growth is being spearheaded mainly by retail investors, private sector institutions and large corporations, smaller companies and state-owned institutions are gradually getting into the act. Foreign brokers such as JP Morgan Chase are boosting their presence in India in reaction to the growth in derivatives. The variety of derivatives instruments available for trading is also expanding. There remain major areas of concern for Indian derivatives users. Large gaps exist in the range of derivatives products that are traded actively. In equity derivatives, NSE figures show that almost 90% of activity is due to stock futures or index futures, whereas trading in options is limited to a few stocks, partly because they are settled in cash and not the underlying stocks. Exchange-traded derivatives based on interest rates and currencies are virtually absent. Liquidity and transparency are important properties of any developed market. Liquid markets require market makers who are willing to buy and sell, and be patient while doing so. A lack of market liquidity may be responsible for inadequate trading in some markets. Transparency is achieved partly through financial disclosure. Financial statements currently provide misleading information on institutions use of derivatives. Further, there is no consistent method of accounting for gains and losses from derivatives trading. Thus, a proper framework to account for derivatives needs to be developed.

Further regulatory reform will help the markets grow faster. For example, Indian commodity derivatives have great growth potential but government policies have resulted in the underlying spot/physical market being fragmented (e.g. due to lack of free movement of commodities and differential taxation within India). Similarly, credit derivatives, the fastest growing segment of the market globally, are absent in India and require regulatory action if they are to develop. As Indian derivatives markets grow more sophisticated, greater investor awareness will become essential. NSE has programmes to inform and educate brokers, dealers, traders, and market personnel. In addition, institutions will need to devote more resources to develop the business processes and technology necessary for derivatives trading.

Uses of derivatives

1. Insurance 2. Hedging 3. Speculation 4. Arbitrage

Insurance and Hedging
One use of derivatives is as a tool to transfer risk by taking the opposite position in the futures market against the underlying commodity. For example, a farmer can sell futures contracts on a crop to a speculator before the harvest. By taking a position in the futures market, the farmer hopes to minimize his or her price risk

Speculation and arbitrage

Speculators may trade with other speculators as well as with hedgers. In most financial derivatives markets, the value of speculative trading is far higher than the value of true hedge trading. As well as outright speculation, derivatives traders may also look for arbitrage opportunities between different derivatives on identical or closely related underlying securities.

Other uses of derivatives are to gain an economic exposure to an underlying security in situations where direct ownership of the underlying security is too costly or is prohibited by legal or regulatory restrictions, or to create a synthetic short position. In addition to directional plays (i.e. simply betting on the direction of the underlying security), speculators can use derivatives to place bets on the volatility of the underlying security. This technique is commonly used when speculating with traded options.

History of derivatives
The history of derivatives is surprisingly longer than what most people think. Some texts even find the existence of the characteristics of derivative contracts in incidents of Mahabharata. Traces of derivative contracts can even be found in incidents that date back to the ages before Jesus Christ. However, the advent of modern day derivative contracts is attributed to the need for farmers to protect themselves from any decline in the price of their crops due to delayed monsoon, or overproduction . The first 'futures' contracts can be traced to the Yodoya rice market in Osaka, Japan around 1650. These were evidently standardised contracts, which made them much like today's futures.

The Chicago Board of Trade (CBOT), the largest derivative exchange in the world, was established in 1848 where forward contracts on various commodities were standardised around 1865. From then on, futures contracts have remained more or less in the same form, as we know them today.

Derivatives have had a long presence in India. The commodity derivative market has been functioning in India since the nineteenth century with organized trading in cotton through the establishment of Cotton Trade Association in 1875. Since then contracts on various other commodities have been introduced as well.

Exchange traded financial derivatives were introduced in India in June 2000 at the two major stock exchanges, NSE and BSE. There are various contracts currently traded on these exchanges.

National Commodity & Derivatives Exchange Limited (NCDEX) started its operations in December 2003, to provide a platform for commodities trading.

The derivatives market in India has grown exponentially, especially at NSE. Stock Futures are the most highly traded contracts on NSE accounting for around 55% of the total turnover of derivatives at NSE, as on April 13, 2005.

Derivatives in India
In India, all attempts are being made to introduce derivative instruments in the capital market. The National Stock Exchange has been planning to introduce index-based futures. A stiff net worth criteria of Rs.7 to 10 corers cover is proposed for members who wish to enroll for such trading. But, it has not yet received the necessary permission from the securities and Exchange Board of India.

In the forex market, there are brighter chances of introducing derivatives on a large scale. Infact, the necessary groundwork for the introduction of derivatives in forex market was prepared by a high-level expert committee appointed by the RBI. It was headed by Mr. O.P. Sodhani. Committees report was already submitted to the Government in 1995. As it is, a few derivative products such as interest rate swaps, coupon swaps, currency swaps and fixed rate agreements are available on a limited scale. It is easier to introduce derivatives in forex market because most of these products are OTC products (Over-the-counter) and they are highly flexible. These are always between two parties and one among them is always a financial intermediary.

However, there should be proper legislations for the effective implementation of derivative contracts. The utility of derivatives through Hedging can be derived, only when, there is transparency with honest dealings. The players in the derivative market should have a sound financial base for dealing in derivative transactions. What is more important for the success of derivatives is the prescription of proper capital adequacy norms, training of financial intermediaries and the provision of well-established indices. Brokers must also be trained in the intricacies of the derivative-transactions. Now, derivatives have been introduced in the Indian Market in the form of index options and index futures. Index options and index futures are basically derivate tools based on stock index. They are really the risk management tools. Since derivates are permitted legally, one can use them to insulate his equity portfolio against the vagaries of the market.

Every investor in the financial area is affected by index fluctuations. Hence, risk management using index derivatives is of far more importance than risk management using individual security options. Moreover, Portfolio risk is dominated by the market risk, regardless of the composition of the portfolio. Hence, investors would be more interested in using index-based derivative products rather than security based derivative products.

There are no derivatives based on interest rates in India today. However, Indian users of hedging services are allowed to buy derivatives involving other currencies on foreign markets. India has a strong dollar- rupee forward market with contracts being traded for one to six month expiration. Daily trading volume on this forward market is around $500 million a day. Hence, derivatives available in India in foreign exchange area are also highly beneficial to the users.

Recent development
At present Derivative Trading has been permitted by the SEBI on derivative segment of the BSE and the F&0 segment of the NSE. The natures of derivative contracts permitted are:

Index Futures contracts introduced in June, 2000, Index options introduced in June, 2001, and Stock options introduced in July 2001.

The minimum contract size of a derivative contract is Rs.2 lakhs. Besides the minimum contract size, there is a stipulation for the lot size of a derivative contract. The lot size refers to number of underlying securities in one contract. The lot size of the underlying individual security should be in multiples of 100 and tractions, if any should be rounded of to next higher multiple of 100. This requirement along with the requirement of minimum contract size from the basis for arriving at the lot size of contract.

Apart from the above, there are market wide limits also. The market wide limit for index products in NIL. For stock specific products it is of open positions. But, for option and futures the following wide limits have been fixed.

30 times the average number of shares traded daily, during the previous calendar month in the cash segment of the exchange. Or 10% of the number of shares held by non-promoters, i.e., 10% of the free float in terms of number of shares of a company

Strategies of Derivatives
1. BUY CALL When market is down, buy just out of money Call. 2. BUY PUT When market is Up and correction is due, buy Put. 3. BUY FUTURE AND SELL CALL When you are bullish but at the same time you want to cover any downward. 4. BULL SPREAD When market is in narrow range, buy IN THE MONEY CALL and sell OUT OF MONEY CALL. 5. CALENDER SPREAD When you want to take TEJI POSITION for the next month, Sell Current Month CALL and Buy Next month Call. 6. STRANGLE When you are not sure in which direction the market will go, Buy CALL & PUT of the same strike price. 7. STRADDLE When results are expected and you do not know in which direction the stock will move, Buy OUT OF MONEY Call and OUT OF MONEY Put.

8. STOCK INSURANCE Buy Future and Buy PUT to cover down side.

9. SELL CALL & PUT In the last days of the Contract Period, Sell naked OUT OF MONEY Call & Put.

Manubhai expects Teji ahead. He buys a Realince Future @ Rs. 437 and sells Reliance 450 Call at the premium of Rs. 6. At the close of contract period, Reliance was Rs. 435. Could Manubhai make profit? If yes, how much ? (Lot Size = 600)
Initially Buying Reliance Future Selling Reliance 450 Call Finally Squaring off Reliance Future Due to Expiry of 450 Call At 435 Profit -262200.00 3600.00 261000.00 2400.00 600 600 435.00 0.00 600 600 -437.00 6.00

In finance, a strangle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, with relatively minimal exposure to the direction of price movement. It is related to a similar option strategy known as a straddle.

Long strangle
The long strangle is a neutral-outlook options trading strategy that involve the simultaneous buying of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying security and expiration date. It is an unlimited profit, limited risk strategy that is taken when the options trader thinks that the price of the underlying security will experience high volatility in the near term. The long strangle is a debit spread as a net debit is taken to enter the trade.

Short strangle
The short strangle is a neutral-outlook options trading strategy that involves the simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying security and expiration date. It is a limited profit, unlimited risk strategy that is taken

when the options trader thinks that the underlying stock will experience little volatility in the near term. The short strangle is a credit spread as a net credit is taken to enter the trade.

Straddle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, regardless of the direction of price movement.

A Long straddle involves going long (i.e. buying) both a call option and a put option on some stock, interest rate, index or other underlying. The two options are typically bought at the same strike price and expire at the same time. The owner of a long straddle makes a profit if the underlying price moves a long way from the strike price, either above or below. Thus, an investor may take a long straddle position if he thinks the market is highly volatile, but does not know in which direction it is going to move.

For example, company XYZ is set to release its quarterly financial results in two weeks. A trader believes that the release of these results will cause a large movement in the price of XYZ's stock, but does not know whether the price will go up or down. He can enter into a long straddle, where he gets a profit no matter which way the price of XYZ stock moves, if the price changes enough either way. If the price goes up enough, he uses the call option and ignores the put option. If the price goes down, he uses the put option and ignores the call option. If the price does not change enough, he loses.

The Short straddle is a non-directional options trading strategy that involves simultaneously selling a put and a call of the same underlying security, strike price and expiration date. The profit is limited to the premiums of the put and call, but it is risky if the underlying security's price goes up or down much. The deal breaks even if the intrinsic value of the put or the call equals the sum of the premiums of the put and call. This strategy is called "unidirectional" because the short straddle profits when the underlying security changes little in price before the expiration of the straddle. The short straddle can also be classified as a credit spread because the sale of the short straddle results in a credit of the premiums of the put and call.

A short straddle position is highly risky, because the potential loss is unlimited, whereas profitability is limited to the premium gained by the initial sale of the options.

The short straddle is a non-directional options trading

Risk in derivative trading

The different types of risks associated with derivative instruments are as follows:

Credit Risk : These are the usual risks associated with counterparty default and which must be assessed as part of any financial transaction. However, in India the two major stock exchanges that offer equity derivative products have Settlement / Trade Guarantee Funds that address this risk

Market Risk : These are associated with all market variables that may affect the value of the contract, for e.g. A change in price of the underlying instrument.

Operational Risk : These are the risks associated with the general course of business operations and include :-

Settlement Risk arises as a result of the timing differences between when an institution either pays out funds or deliverables assets before receiving assets or payments from a counterparty and it occurs at a specific point in the life of the contract.

Legal Risk arises when a contract is not legally enforceable, reason being the different laws that may be applicable in different jurisdictions - relevant in case of cross border trades.

Deficiencies in information, monitoring and control systems, which result in fraud, human error, system failures, management failures etc. Famous examples of these risks are the Nick Lesson case, Barings' losses in derivatives, Society General's debacle etc.

Strategic

Risk

These

risks

arise

from

activities

such

as:

o o o o

Entrepreneurial behavior of traders in financial institutions Misreading client requests Costs getting out of control Trading with inappropriate counterparties

Systemic Risk : This risk manifests itself when there is a large and complex organization of financial positions in the economy. "Systemic risk" is said to arise when the failure of one

big player or of one clearing corporation somehow puts all other clearing corporations in the economy at risk. At the simplest, suppose that an index arbitrageur is long the index on one exchange and short the futures on another exchange. Such a position generates a mechanism for transmission of failure - the failure of one of the exchanges could possibly influence the other. Systemic risk also appears when very large positions are taken on the OTC derivatives market by any one player. Neither of these scenarios is in the offing in India. Hence it is hard to visualize how exchange traded derivatives could generate systemic risk in India.

Technical Analysis And Derivatives Trading

In making decisions about where and when to take a position, investors, traders and analysts use two different approaches: fundamental analysis and technical analysis. Fundamental analysis is the appreciation of the economics underlying a particular trade. If you want to know where to invest and why, you use the techniques of fundamental analysis. Technical analysis is concerned with the when and the how of placing money. It determines the optimal timing for a position and its conclusions about how long to stay in a particular trade have significant importance for the kind of derivatives structure one may use to take a position.

For a foreign exchange trader, fundamental analysis is focused on the macroeconomics of the particular currencies involved, including the implications of the current account, the GDP growth rate, domestic consumption, domestic production and other political factors that influence the currency's relative value. As we move into more company-specific investments such as individual equities, fundamental analysis becomes more preoccupied with microeconomic questions related to the firm. Such an investigation might look at price/earnings ratios, debt/equity ratios, cash flow forecasts and similar data from financial statements, press releases and competitors.

Technical analysis is an art in which quasi-statistical techniques and formal statistics are used to determine the existence and strength of trends in financial time series and to identify turning points in these trends. If you can do this with a reasonable degree of accuracy, then you can improve your chances of making a profitable trade. Technical analysis is important in the structuring of derivative products because of the leverage involved and because of the inclusion of such features as barriers and compound strikes. Timing is everything.

EXAMPLES OF TECHNICAL ANALYSIS

There are two kinds of technical analysis.

First, there is the design and use of "indicators", changes in which present implications about the existence, strength or change in the trend of the financial time series in question. An indicator is a function of the time series and some parameters that the analyst chooses.

Second, there is the use of more primitive hands-on techniques such as the drawing of "support" and "resistance" lines on a chart, the violation of which is deemed to be a significant technical event. In its more complex manifestations, "patterns" are interpolated from market behavior with conclusions for future price evolution based upon the historical consequences of such patterns.

There is a growing voice in technical analysis that argues against this second school of thought. The argument against interpolating lines and patterns comes from a basic assumption about the psychology of money. In order for technical analysis to be successful in forecasting future price movements, the analysis must be objective.

Otherwise, the analyst will see what he wants to see. I myself have seen traders, especially ones with large positions that have started to lose money, fool themselves into thinking that they can justify their current positions with some lines on a chart. Hope is the principal obstacle to profitable trading.

Presume then that derivative traders who use technical analysis stick firmly to the first school, the use of indicators.

Advances in computer technology make it easy to automate this analysis by programming what are called expert rules. This obviates the problem of seeing what one wants to see quite clearly. And it allows the analyst to customize the indicator to time series in question in order to get the most optimal results.

For example, a momentum indicator is a simple formula involving the most recent price and some historical price that gauges the speed of the move in the financial time series.

A moving average is simply an average over the last few periods for the time series. Construct two moving averages with different periods and you have a trading signal when they cross. When the moving average with the longer indicator crosses the moving average with the shorter indicator, you have a good indicator of a trend in place.

By using contemporary software such as Omega Research's (http://www.omegaresearch.com) Super Charts, the analyst can choose the two periods for the two moving averages that produce the optimal results. This will vary between different time series because every time series has its own peculiar quirks. The Canadian Dollar against the US dollar moves much more differently than the Japanese Yen against the US dollar. Reasonably, we would expect them to have different parameters for our moving average crossover trading signal.

Another indicator might track the "Stochastic". This is another crossover indicator that is more suitable for a non-trending market.

Indicators are typically suited for a particular kind of market, usually delineated by whether or not the market is trending.

There are many good resources for Technical Analysis, including books by John Murphy. Check out the Financial Pipeline bookstore.

Summarization of derivatives market

1: Benefits and Risks of Derivative Markets
Asian derivative markets go back to 17th century rice trading in Japan and have grown rapidly over the last decade.

Derivative contracts allow the trading of agricultural or financial instruments in the future at predetermined prices.

Those standardized contracts that are traded at an organized exchange are called exchange-traded derivatives (ETD) and those customized contracts that are traded individually are called overthe-counter (OTC) derivatives.

A few examples can illustrate the substantial developmental benefits that derivative markets can create for the economy: The earliest innovation helped farmers to reduce uncertainty over future prices of their commodities, where buyers and sellers would contractually agree on next years price for standardized products such as corn, soybean, or wheat, Aluminum, copper, or crude-oil.

Producers have been able to reduce large cyclical swings and consumers have been able to rely on less volatile prices, which has increased economic efficiency More recently, the Asian crisis revealed the need for a spare tire whereby corporations would not only rely on bank loans but also seek financing from debt capital markets. When issuers offer floating-rate debt, borrowers can use interest rate swaps, options, or futures to lock-in future interest rates at a fee, which can help them gain flexibility for future production and reduce Volatility from economic cycles. Standardized futures contracts on agricultural commodities, metals, and interest rates are today commonly traded at over 20 derivative exchanges across Asia.

More recent innovations reveal the vast benefits that risk sharing in capital markets can create. While flood insurance has been a traditional insurance product, more extreme catastrophic events such as earthquakes require stronger balance sheets than insurance (or even reinsurance) companies can provide. Investors in capital markets can choose to buy so-called CAT bonds that carry high interest rates but may loose their principal in case a predefined catastrophic event occurs during the agreed duration.

In the area of housing finance, consumers enjoy lower mortgage rates when banks can bundle a large portfolio of mortgage loans and sell structured products in capital markets that differentiate pricing for tranches with different credit risk.

Various credit derivatives, foreign exchange derivatives, and more exotic options are today traded in mostly unregulated OTC derivative markets.

Various advantages and disadvantages of derivative markets have been studied in the literature. Concerns arise: Especially in the areas of accounting and transparency, leverage and corporate governance, as well as on counterparty and potential systemic risks in unregulated markets.

An analogy may help to illustrate the trade-offs: Car insurance can be regarded as a derivative product where the insurance company makes a future contingent payment in case of car accidents in return for a premium paid by the car owner.

By pooling the risk, insurance can lower the cost to car owners, and generate a profit for the intermediary. However, the protection might induce some motorists to become more reckless in their driving and ultimately drive up accident and premium rates.

Nobody would argue that economies are better off without car insurance. Obviously, solid regulatory frameworks, strong risk management practices, and close supervision are indispensable.

Market efficiency More leverage Risk sharing and transfer Less transparency Low transaction costs Dubious accounting Capital intermediation Regulatory arbitrage Liquidity enhancement Hidden systemic risk Price discovery Counter-party risk Cash market development Tail-risk future exposure Hedging tools Weak capital requirements Regulatory savings Zero-sum transfer tools

REFRENCES USED
Investopedia Nseindia.com Indian derivatives Bseindia.com Derivatives.com John C. Hull (option, futures and derivatives) Global finance

Declaration:
This project on Currency Derivatives in Indian Currency Market has been undertaken in INDIA INFOLINE PVT. LTD. (IIFL), a private sector company, is submitted by me, in partial fulfillment of the requirement for Post Graduate Diploma in Management is an original work of mine. I declare that this project report has not published previously elsewhere. It is a result of my own effort and has been undertaken solely for academic purposes. All education material consulted in course of the study has been declared in the reference and all information provided in the project report is true to the best of my knowledge. This work has not been submitted in part or in full to any other institute or any other university for any kind of award of any degree or any diploma.

Signature of Student: _____________ Name of Student: ________________

Signature of Company Mentor: ___________ Name of Company Mentor: ______________ Designation: __________________________

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