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Analysis of Derivative Strategies under different market conditions

CHAPTER - 1 INTRODUCTION
The emergence of the market for derivative products, notably Futures and Options, can be traced back to the willingness of risk aversive investors to guard themselves against uncertainties arising out of fluctuations in asset prices. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking in asset prices. Derivative products initially emerged as hedging devices against fluctuations in commodity prices. Commodity-linked derivates remained the dole form of such products for almost three hundred years. The advent of modern day derivative contracts can be attributed to the need for farmers to protect their produce from any decline in the prices of their crops. The most important use of derivatives is in transferring market risk, called hedging which a protection against losses is resulting from unforeseen price or versatility changes. Thus, derivatives are a very important tool of risk management. Strategies allows a market participant to lock in prices and margins in advance and reduces the potential for unanticipated lose or competitive disadvantage. The principal behind establishing equal and opposite position in the cash and future market should be offset by a gain in the other market so the study is conducted to analyze how to reduce the risk of investor in the market. This project examines the various derivative strategies and their suitability. In this project derivative trading strategies are discussed. The main objective of study is how to minimize risk by using derivative strategies. In carrying out this project, the secondary data is derived from the reports of NSE and various other websites and magazines. The scheme explains the scope of the study and the research design tells the methodology adopted and interpretation made. It consists of diagrammatical analysis, findings and giving suggestion for trading in derivatives.

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Analysis of Derivative Strategies under different market conditions

The study focuses on understanding the various derivative strategies and in what market situation it can be implemented. An attempt is made to understand derivative strategies in depth and suggest the measures to minimize risk for the investor.

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Analysis of Derivative Strategies under different market conditions

CHAPTER -2 RESEARCH DESIGN


2.1 INTRODUCTION TO THE STUDY
The emergence of the market for derivative products, notably Futures and Options, can be traced back to the willingness of risk aversive investors to guard themselves against uncertainties arising out of fluctuations in asset prices. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking in asset prices. Derivative products initially emerged as hedging devices against fluctuations in commodity prices. Commodity-linked derivates remained the dole form of such products for almost three hundred years. The advent of modern day derivative contracts can be attributed to the need for farmers to protect their produce from any decline in the prices of their crops.

2.2 STATEMENT OF THE PROBLEM


Analysis of derivative strategies under different market condition in India Infoline Limited

2.3 OBJECTIVES OF STUDY


To analyze the future/options strategies. To study application and suitability of derivatives strategies under different market condition. To study the impact of derivative strategies on risks and profits. To give suitable suggestions to the investors based on the study conducted.

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Analysis of Derivative Strategies under different market conditions

2.4 METHODOLOGY
Research design indicates a plan of action to be carried out in connection with the proposed objective. It provides a guidance to enable to keep track of action in order to achieve the goals. This is a descriptive study in which an attempt is made to evaluate the strategies of derivatives and their adoptability in the capital market. It includes data collection and the job done as a researcher is to use the strategies in the regular market. The study is conducted on the aspects like Detail study about derivative strategies. Risk minimization by using strategy.

2.5 SCOPE OF STUDY


This study is done on the basis of ACC futures & options. This study pertains to only 12 strategies. The opening and closing prices have been taken for Six to Twelve days for the purpose calculation.

2.6 SOURCES OF DATA


The study was made through literature collected from internet, business magazines, news papers and text books.

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Analysis of Derivative Strategies under different market conditions

2.7 LIMITATIONS OF THE STUDY


The sample size taken for research may not give exact figure or may not cover population.
The next important constraint is the time limit since the study had to be conducted in a short span of time, the accuracy may be biased.

The study is limited to the secondary data only.


The research work does not consider other type of market such as commodity market etc.

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Analysis of Derivative Strategies under different market conditions

CHAPTER 3 PROFILES
3.1 INDUSTRY PROFILE
The emergence of the market for derivative products, notably Futures and Options, can be traced back to the willingness of risk aversive investors to guard themselves against uncertainties arising out of fluctuations in asset prices. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking in asset prices. Derivative products initially emerged as hedging devices against fluctuations in commodity prices. Commodity-linked derivates remained the dole form of such products for almost three hundred years. The advent of modern day derivative contracts can be attributed to the need for farmers to protect their produce from any decline in the prices of their crops. For example if a farmer wanted to save his produce against any decline in topics due to natural calamities or any loss or production, he can enter into a future agreement with the buyer wherein he can fix the price at which he is going to sell the produce at a future date. In this way, the farmer is headed against any risk that could have been exposed to in the future. In the same way options are similar to insurance products whereby the insured pays a premium to insure his assets. The option buyer pays a small price; which is the premium, to insure his stock prices against any fall in the underlying by buying a put option. The financial derivatives came into spotlight post 1970 due to growing, instability in the financial markets. The first stock index futures contract introduced in the stock index futures contract introduced in the world was the Value line contract, introduced by the
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Analysis of Derivative Strategies under different market conditions

Kansas City Board of Trade in 1982 in the USA. Since then we have seen numerous markets all over the world launching new derivative contracts every year. In recent years, the market from financial derivatives has grown tremendously both in terms of variety of instrument available, their complexity and also turnover. The advent of stock index futures and options has profoundly changed the nature of trading on stock exchanges. The concern over how trading in futures contracts affects the spot market for underlying assets has been an interesting subject for investors, market makers, academician, exchange and regulators altering the composition of their portfolios and in timing their transactions. Future markets also provide opportunities to hedge the risks involved with holding diversified equity portfolios As a consequence, significant portion of cash market equity transaction are tied to futures and options market activity

HISTORY OF DERIVATIVES TRADING As the market grows, there is a need for different investments, which enable investors and participants to diversify as well as control the different risk in the capital market. An options and futures market fulfills the need for hedging against market risk in a cost-efficient way while it strengthens and deepens the cash market. However, before derivatives trading could be introduced, it was necessary to include derivatives instruments in the definition of securities contract act, 1956 (SCRA). Accordingly, the securities laws act, 1999 was enacted to provide the legal frame work for introduction of derivatives trading in Indian securities market. Derivatives trading have commenced in Indian Equity market with trading in Stock Index futures from 9th June 2000. Stock index options and options were introduced since June and July 2001 respectively. Single stock futures stocks have also been introduced since 9th of November 2001. The recommendations of the advisory committee on derivatives have been approved by the SEBI board on 29th November, 2002. Some of the major recommendations include introduction of derivatives on other financial products, settlement in the underlined securities, expansion of list of securities in which derivatives trading is permitted,

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Analysis of Derivative Strategies under different market conditions

introduction of cross margining, client level position restriction and reduction in minimum contract size. SEBI considered the applications made by NSE and the stock exchange Mumbai for introduction of F and O contracts on additional stocks found eligible by the Exchanges based on the criteria laid down by advisory committee on derivatives and 9th January 2003 granted permission to the exchange to introduce F and O contracts on 31 additional stocks on the NSE and additional 21 stocks the BSEs. The National Stock Exchange of India Ltd. (NSE), set up in the year 1993, is today the largest stock exchange in India and a preferred exchange for trading in equity, debt and derivatives instruments by investors. NSE has set up a sophisticated electronic trading, clearing and settlement platform and its infrastructure serves as a role model for the industry. The standards set by NSE in terms of market practices; products and technology have become industry benchmarks and are being replicated by many other market participants. NSE has four broad segments Wholesale Debt Market Segment (commenced in June 1994), Capital Market Segment (commenced in November 1994) Futures and Options Segment (commenced June 2000) and the Currency Derivatives segment (commenced in August 2008). Various products which are traded on the NSE include, equity shares, bonds, debentures, warrants, exchange traded funds, mutual funds, government securities, futures and options on indices & single stocks and currency futures. Today NSEs share to the total equity market turnover in India averages around 72% whereas in the futures and options market this share is around 99%. At NSE, it has always been our endeavor to continuously upgrade the skills and proficiency of the Indian investor. Exchange-traded options form an important class of derivatives which have standardized contract features and trade on public exchanges, facilitating trading among investors. They provide settlement guarantee by the Clearing Corporation thereby reducing counterparty risk. Options can be used for hedging, taking a view on the future direction of the market or for arbitrage. Options are also helpful for implementing various trading strategies such as straddle, strangle, butterfly, collar etc. which can help in generating income for investors under various market conditions. This module is being introduced to explain some of the important and basic Options

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Analysis of Derivative Strategies under different market conditions

strategies. The module which would be of interest to traders, investors, students and anyone interested in the options markets. However, it is advisable to have a good knowledge about the basics of Options or clear the NCFM Derivatives Markets (Dealers) Module before taking up this module. To get a better clarity on the strategies, it is important to read the examples and the pay-off schedules. The pay-off schedules can be worked out using a simple excel spreadsheet for better understanding. We hope readers find this module a valuable addition which aids in understanding various Options Trading Strategies.

Linkages between cash and derivatives Following the introduction of derivative contracts in developed markets like the US and UK, researchers have sought to analyze the impact of directives introduction on the volatility and efficiency of the underlying cash market. The empirical evidence is, however, quite mixed. Most studies summarizes that the introduction of derivatives does not destabilize the underlying market, either there is no effect or perhaps only a very small decline in volatility. India: Growth story The Indian financial markets took a giant leap ahead with the introduction of derivatives trading on the stock exchanges. The derivatives trading in India commenced with the introduction of the index futures in June 2000. The advent of stock futures and options in 2001 resulted in a dramatic increase in the volumes of derivatives. In less than three years, the volumes in the Futures and Options segment rose more than that of the cash market. Since then, the volumes in the F&O segment have witness huge growth. Currently, the volumes in the Futures and Options segment rose more than that of the cash market. Since then, the volumes in the F& O segment have witnessed huge growth, currently the volumes in F&O are consistently around for to five times more than the cash market volumes. This in itself reflects the huge popularity of these instruments among the retail and institutional investors alike. Going ahead, the derivative markets are expected to see a future rise with the increase in knowledge levels among the investors about these products,

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Analysis of Derivative Strategies under different market conditions

they also act as a very useful hedging toll for institutional investors who would like to protect their holdings against any negative surprises. With the government liberalizing norms for mutual fund participation in the derivatives segments, the participation is expected to rise further in the future. The mutual fund industry is also launch derivative funds where the primary focus would be to generate returns through investment in derivatives. Moreover with the Indian stock markets generating astronomical returns in the last few years, the future prospects of derivatives looks extremely bright.

Derivatives Trading Volume in India


Stock Options 2% Index Options 10%

Stock Futures 47%

Index Futures 41%

EXCHANGES OFFERING DERIVATIVE TRADING IN INDIA


NCDEX-it only deals in commodity derivatives mainly food grains, edible oil

etc.
MCX- It mainly deals in bullions etc. NSE- It is the largest financial derivative exchange in India. BSE- Bombay Stock Exchange also offers derivative trading of selective

stocks.

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Analysis of Derivative Strategies under different market conditions

Derivatives in India: A Chronology:


14 December 1995: NSE asked SEBI for permission to trade Index futures. 18 November 1996: SEBI setup L. C. Gupta Committee to Draft a policy framework for index futures 11 May 1998: L. C. Gupta Committee submitted report 7 July 1999: RBI gave permission for OTC forward rate agreements (FRAs) and interest rate swaps. 24 May 2000 SIMEX chose Nifty for trading futures and options on an Indian index. 25 May 2000: SEBI gave permission to NSE and BSE To do index futures trading. 9 June 2000: Trading of BSE Sensex futures commenced At BSE. 12 June 2000: Trading of Nifty futures commenced at NSE. 31 August 2000: Trading of futures and options on Nifty to Commence at SIMEX.

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Analysis of Derivative Strategies under different market conditions

The trading volume on NSEs derivatives market has seen a steady increase since the launch of the first derivatives contract, i.e. index futures in June 2000. The average daily turnover at NSE now exceeds a 1000 crore. A total of 41,96,873 contracts with a total turnover of Rs.1, 01,926 crore was traded during 2001-2002. Market concentration Contribution to the total turnover Month Institutional investors Gross Traded Value (crores) Jul 08 Aug 08 Sep 08 Oct 08 Dec 08 2,50,935 2,90,713 2,33,594 1,66,700 1,78,52 1 1,84,70 1 Retail Percentag e Contribu Tion 56.40% 56.85% 54.95% 56.04% 56.34% Proprietary

Percentag Gross e Traded Contri Value Bution (crores) 13.10% 12.13% 12.40% 11.18% 10.77% 10,79,934 13,61,914 10,34,923 8,35,439 9,34,367

Gross Traded Value (crores) 5,84,021 7,43,118 6,14,776 4,88,574 5,45,444

Percentag e Contribu tion 30.50% 31.02% 32.64% 32.77% 32.89%

Jan 09

11.87%

8,69,059

55.84%

5,02,477

32.29%

(Source: www.nseindia.com) From the above table, it is observed that the contribution of the Institutional Investors to the total turnover has increased from 6.28% to 8.36% over the last few months where as the share of Proprietary has declined from 32.29% to 28.30 during the same period. The contribution of the Retail segment has increased to 63.34% from 59.87%.

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Analysis of Derivative Strategies under different market conditions

Product concentration The National Stock Exchange of India Limited has launched different products as an instrument for trading over the period of years. The instruments are: S & P CNX Nifty Futures S & P CNX Nifty Options CNXIT Futures CNXIT Options Bank Nifty Futures Bank Nifty Options Futures on individual Securities Options on Individual Securities

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Analysis of Derivative Strategies under different market conditions

Market Share for the different products in the derivative segment Year 2005-06 2004-05 2003-04 2002-03 2001-02 2000-01 Index Futures 31.38% 30.32% 26.03% 9.99% 21.08% 100% Stock Futures 57.87% 58.27% 61.30% 65.14% 50.54% Index Options 7.02% 4.79% 2.48% 2.10% 3.69% Stock Options 3.74% 6.63% 10.20% 22.76% 24.69% -

Stock Futures holds the maximum market share of the total turnover in the derivatives segment. For the year April 2005 - March 2006, Stock futures had a market share of 57.87% followed by the Index futures where the market share stands at 31.38%. Index Options had a market share of 7.02 % whereas the Stock Options market share stands at 3.74% of the total turnover. From the above table, it is observed that the market share of the Index Future and the Index Options shows an upward trend for the last four years whereas the market share of the Stock Futures and the Stock Options has decreased over the same period of time.

Opportunities for various segments of investors- Retail, HNI, FIIs, MFs For the retail traders, derivatives offer an undoubted advantage of leveraging 4-6 times their investable amount. The minimum amount one would require to trade in futures could be a minimal as Rs.20000. Options on the other hand can allow you to take positions
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Analysis of Derivative Strategies under different market conditions

even with a meager principal amount, catering even to the most marginal traders. Larger investors can make use of this leverage for the purpose of investing. People holding substantial shares in any derivative stocks can dilute the same in the cash market and pick up the same asset via its underlying derivative contract, as this would scale down their investment substantially and free up cash fledging is the most sailable feature of any derivative instrument and also the primary purpose for their creation. Instructions funds often use these instruments to hedge their cash market position, or make use of writing options to earn some money in range bound markets. As funds can only limit themselves to hedging and cannot take speculative positions, arbitrage opportunities offer scope to make safe money. This free money would add in to their regular capital appreciation and dividend incomes.

Future prospects & outlook With the Bull Run entering a new orbit in 2006, the NSE has managed to consolidate its position to the 7th spot in the global league of derivative markets, based on daily turnover. The NSE rose from the 10th position seen in 2004, with contract volume rising from Rs.67 million to 116 million, a lump of 72.50 percent. It is not surprising that the top three exchanges in terms of volumes were homed in developed countries. They include the Chicago Mercantile Exchange (883 million contracts), Eurex (784 million contracts) and Chicago Board of Trade (561 million contracts). But, the emergence of developing countries in the financial arena has been commendable. Brazil, India, Mexico and China domiciled four of the worlds 10 largest futures exchanges. Studies point out that the recent growth in international traded volume has come from the spread of futures and options, trading in new parts of the globe. The main factor that has closely aided this development has been the raid progress in electronic trade. This has had a southward impact on trading costs and has given liquidity to hedge fund activity in the futures and options market. One of the factors that has been' highlighted in the growth of the Indian derivative market has been the unusually small contract size by global standards. NSE had initially

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Analysis of Derivative Strategies under different market conditions

kept the average value of a derivative futures contract at a steep Rs.2 lakh at the start, to discourage retail investors from playing in a nascent market. However the small contract value has spurred the development of the market. With the upward movement in stock prices most lot sizes were revised to scale down the value of the contract. However, the steep contract values did not deter the retail crowd who now constitute nearly 60% of the daily traded volume. Over the passage of time more stocks have been added to the derivative list including liquid mid caps across a range of sectors. NSE has also ignored its minimum 6-monthtrading history criteria, which has allowed the immediate entry of many large primary issues such as TCS, Jet Air, Punj Llyod, IDFC, Suzlon and JPHydro to name a few. It is likely that the growth of the Indian market would naturally usher more liquidity not only in contract volume, but also in maturity. The current contracts have up to 3month contract expiry; with very thin contract volume in the mid month and far month series. This largely restricts the efficiency of the market by tilting the impacting cost upwards. The Indian markets are still in a growth phase with many large caps in India being considered as mid-caps in accordance with global standards. Tile derivative market still has a long way to go, and are definitely on the right track.

EMERGENCE OF DERIVATIVES MARKET With globalization of the financial sector, it's time to recast the architecture of the financial market. The liberalized policy being followed by the Government of India and the gradual withdrawal of the procurement and distribution channel necessitated setting in place a market mechanism to perform the economic functions of price discovery and risk management. Till the mid 1980's, the Indian financial system did not see much innovation. In the last 18 years, financial innovation in India has picked up and it is expected to grow in the years to come, as a more liberalized environment affords greater scope for financial innovation at the same time financial markets are, by nature, extremely volatile and hence the risk factor is an important concern for financial agents. To reduce this risk, the concept of derivatives comes into the picture. Derivatives are products whose

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values are derived from one or more basic variables called bases. India is traditionally an agriculture country with strong government intervention. Government arbitrates to maintain buffer stocks, fix prices, impose import-export restrictions, etc.

Derivatives are financial contracts whose values are derived from the value of an underlying primary financial instrument, commodity or index, such as: interest rates, exchange rates, commodities, and equities. Derivatives include a wide assortment of financial contracts, including forwards, futures, swaps, and options. The International Monetary Fund defines derivatives as "financial instruments that are linked to a specific financial instrument or indicator or commodity and through which specific financial risks can be traded in financial markets in their own right. The value of financial derivatives derives from the price of an underlying item, such as asset or index. Unlike debt securities, no principal is advanced to be repaid and no investment income accrues." While some derivatives instruments may have very complex structures, all of them can be divided into basic building blocks of options, forward contracts or some combination thereof. Derivatives allow financial institutions and other participants to identify, isolate and manage separately the market risks in financial instruments and commodities for the purpose of hedging, speculating, arbitraging price differences and adjusting portfolio risks. The emergence of the market for derivatives products, most notable forwards, futures, options and swaps 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 can be subject to 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, derivatives products generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivatives products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors

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Analysis of Derivative Strategies under different market conditions

Factors generally attributed as the major driving force behind growth of financial derivatives are: (a) Increased Volatility in asset prices in financial markets, (b) Increased integration of national financial markets with the international markets, (c) Marked improvement in communication facilities and sharp decline in their costs, (d) Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and (e) Innovations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets, leading to higher returns, reduced risk as well as transaction costs as compared to individual financial assets.

Development of exchange-traded derivatives Derivatives have probably been around for as long as people have been trading with one another. Forward contracting dates back at least to the 12th century, and May well have been around before then. Merchants entered into contracts with one another for future delivery of specified amount of commodities at specified price. A primary motivation for pre-arranging a buyer or seller for a stock of commodities in early forward contracts was to lessen the possibility that large swings would inhibit marketing the commodity after a harvest.

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Analysis of Derivative Strategies under different market conditions

The need for a derivatives market The derivatives market performs a number of economic functions: 1. They help in transferring risks from risk adverse 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 adverse people in greater numbers 5. They increase savings and investment in the long run

Types of Derivatives
Derivative contracts have several variants. The most common variants are forwards, futures, options and swap. Derivatives markets have had a slow start in India. The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws (Amendments) Ordinance, 1995, which withdrew the prohibition on options in securities. The market for derivatives, however, did not take off, as there was no regulatory framework to govern trading of derivatives. SEBI set up a 24-member committee under the Chairmanship of Dr. L.C. Gupta on 18th November 1996 to develop appropriate regulatory framework for derivatives trading in India. The committee recommended that derivatives should be declared as 'securities' so that regulatory framework applicable to trading of 'securities' could also govern trading of securities. SEBI was given more powers and it starts regulating the stock exchanges in a professional manner by gradually introducing reforms in trading. Derivatives trading commenced in India in June 2000 after SEBI granted the final approval in May 2000. SEBI permitted the derivative segments of two

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Analysis of Derivative Strategies under different market conditions

stock exchanges, viz NSE and BSE, and their clearing house/corporation to commence trading and settlement in approved derivative contracts. Following the committee's recommendations, the Securities Contract Regulation Act (SCRA) was amended in 1999 to include derivatives within the scope of securities, and a regulatory framework for administering derivatives trading was laid out. The act granted legality to exchange-traded derivatives, but not OTC (over the counter) derivatives. It allowed derivatives trading either on a separate and independent derivatives exchange or on a separate segment of an existing stock exchange. The derivatives exchange had to function as a self-regulatory organization (SRO) and SEBI acted as its regulator. The responsibility of clearing and settlement of all trades on the exchange was given to the clearing house which was to be governed independently.

Introduction of derivatives was made in a phase manner allowing investors and traders sufficient time to get used to the new financial instruments. On June 9, 2000, the Bombay Stock Exchange (BSE) introduced India's first derivative instrument - the BSE30(Sensex) index futures. It was introduced with three month trading cycle - the near month (one), the next month (two) and the far month (three). The National Stock Exchange (NSE) followed a few days later, by launching the S&P CNX Nifty index futures on June 12, 2000.The trading in index options commenced in June 2001 and trading in options on individual securities commenced in July 2001. Futures contracts on individual stock were launched in November 2001. In June 2003, SEBI/RBI approved the trading in interest rate derivatives instruments and NSE introduced trading in futures contract on June 24, 2003 on 91 day Notional T-bills. Derivatives contracts are traded and settled in accordance with the rules, bylaws, and regulations of the respective exchanges and their clearing house/corporation duly approved by SEBI and notified in the official gazette. The plan to introduce derivatives in India was initially mooted by the National Stock Exchange (NSE) in 1995. The main purpose of this plan was to encourage greater participation of foreign institutional investors (FIIs) in the Indian stock exchanges.

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Analysis of Derivative Strategies under different market conditions

Their involvement had been very low due to the absence of derivatives for hedging risk. However, there was no consensus of opinion on the issue among industry analysts and the media. The pros and cons of introducing derivatives trading were debated intensely. The lack of transparency and inadequate infrastructure of the Indian stock markets were cited as reasons to avoid derivatives trading. Derivatives were also considered risky for retail investors because of their poor knowledge about their operation. In spite of the opposition, the path for derivatives trading was cleared with the introduction of Securities Laws (Amendment) Bill in Parliament in 1998. The introduction of derivatives was delayed for some more time as the infrastructure for it had to be set up. Derivatives trading required a computer-based trading system, a depository and a clearing house facility. In addition, problems such as low market capitalization of the Indian stock markets, the small number of institutional players and the absence of a regulatory framework caused further delays. Derivatives trading eventually started in June 2000. The introduction of derivatives was well received by stock market players. Trading in derivatives gained substantial popularity, and soon the turnover of the NSE and BSE derivatives markets exceeded the turnover of the NSE and BSE cash markets. For instance, in the month of January 2004, the value of the NSE and BSE derivatives markets was Rs.3278.5 billion (bn) whereas the value of the NSE and BSE cash markets was only Rs.1998.89 bn. In spite of these encouraging developments, industry analysts felt that the derivatives market had not yet realized its full potential. Analysts pointed out that the equity derivative markets on the BSE and NSE had been limited to only four products index futures, index options and individual stock futures and options which were limited to certain select stocks.

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Analysis of Derivative Strategies under different market conditions

Few of the commodity-derivatives exchanges are:

National Commodity & Derivatives Exchange Limited (NCDEX) National Multi Commodity Exchange of India Limited (NMCEIL) Multi Commodity Exchange of India Limited (MCX)

And the products traded are: Agro products such as Basmati Rice, Castor Oil, Chana, Coffee Cotton, Crude Oil, Gaur, Gur, Jeera, Jute, Maize, Mustard, Peas, Pepper, Red Chilli, Rice, Rubber, Soya beans, Sugar, Turmeric, Urad, Wheat, Metal products such as Copper, Gold, Silver, Steel. Etc

3.2 COMPANY PROFILE About India Infoline


India Infoline is a one-stop financial services shop, most respected for quality of its advice, personalised service and cutting-edge technology.

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Analysis of Derivative Strategies under different market conditions

Vision
Our vision is to be the most respected company in the financial services space.

India Infoline Group


The India Infoline group, comprising the holding company, India Infoline Limited and its wholly-owned subsidiaries, straddle the entire financial services space with offerings ranging from Equity research, Equities and derivatives trading, Commodities trading, Portfolio Management Services, Mutual Funds, Life Insurance, Fixed deposits, GoI bonds and Other small savings instruments to loan products and Investment banking. The company has a network of 976 business locations (branches and sub-brokers) spread across 365 cities and towns. It has more than 800,000 customers.

India Infoline Ltd


India Infoline Limited is listed on both the leading stock exchanges in India, viz. the Stock Exchange, Mumbai (BSE) and the National Stock Exchange (NSE) and is also a member ofboth the exchanges. It is engaged in the businesses of Equities broking, Wealth Advisory Services and Portfolio Management Services. It offers broking services in the Cash and Derivatives segments of the NSE as well as the Cash segment of the BSE. It is registered with NSDL as well as CDSL as a depository participant, providing a one-stop solution for clients trading in the equities market. It has recently launched its Investment banking and Institutional Broking business.

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Analysis of Derivative Strategies under different market conditions

A SEBI authorized Portfolio Manager; it offers Portfolio Management Services to clients. These services are offered to clients as different schemes, which are based on differing investment strategies made to reflect the varied risk-return preferences of clients.

India Infoline Media and Research Services Limited.


The content services represent a strong support that drives the broking, commodities, mutual fund and portfolio management services businesses. Revenue generation is through the sale of content to financial and media houses, Indian as well as global. It undertakes equities research which is acknowledged by none other than Forbes as 'Best of the Web' and 'a must read for investors in Asia'. India Infoline's research is available not just over the internet but also on international wire services like Bloomberg (Code: IILL), Thomson First Call and Internet Securities where India Infoline is amongst the most read Indian brokers.

India Infoline Commodities Limited.


India Infoline Commodities Pvt Limited is engaged in the business of commodities
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Analysis of Derivative Strategies under different market conditions

broking. Our experience in securities broking empowered us with the requisite skills and technologies to allow us offer commodities broking as a contra-cyclical alternative to equities broking. We enjoy memberships with the MCX and NCDEX, two leading Indian commodities exchanges, and recently acquired membership of DGCX. We have a multichannel delivery model, making it among the select few to offer online as well as offline trading facilities.

India Infoline Marketing & Services


India Infoline Marketing and Services Limited is the holding company of India Infoline Insurance Services Limited and India Infoline Insurance Brokers Limited. (a) India Infoline Insurance Services Limited is a registered Corporate Agent with the Insurance Regulatory and Development Authority (IRDA). It is the largest Corporate Agent for ICICI Prudential Life Insurance Co Limited, which is India's largest private Life Insurance Company. India Infoline was the first corporate agent to get licensed by IRDA in early 2001.
(b) India Infoline Insurance Brokers Limited India Infoline Insurance Brokers Limited is a newly formed subsidiary which will carry out the business of Insurance broking. We have applied to IRDA for the insurance broking licence and the clearance for the same is awaited. Post the grant of license, we propose to also commence the general insurance distribution business.

India Infoline Investment Services Limited


Consolidated shareholdings of all the subsidiary companies engaged in loans and financing activities under one subsidiary. Recently, Orient Global, a Singapore-based investment institution invested USD 76.7 million for a 22.5% stake in India Infoline Investment
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Analysis of Derivative Strategies under different market conditions

Services. This will help focused expansion and capital raising in the said subsidiaries for various lending businesses like loans against securities, SME financing, distribution of retail loan products, consumer finance business and housing finance business. India Infoline Investment Services Private Limited consists of the following step-down subsidiaries. (a) India Infoline Distribution Company Limited (distribution of retail loan products) (b) Moneyline Credit Limited (consumer finance) (c) India Infoline Housing Finance Limited (housing finance)

IIFL (Asia) Pte Limited


IIFL (Asia) Pte Limited is wholly owned subsidiary which has been incorporated in Singapore to pursue financial sector activities in other Asian markets. Further to obtaining the necessary regulatory approvals, the company has been initially capitalized at 1 million Singapore dollars.

CHAPTER 4 REVIEW OF LITERATURE


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Study on Derivatives Derivative Derivative is a contract underlying where value is derived from the value of the underlying asset can be index, securities, commodities, bullion, currency, live stock etc. Derivatives are contractual in nature. They give the investor the facility to buy or sell the underlying at a pre specified price and time. Products in derivatives Derivatives have many Products like Forwards, futures, options, swaps etc. Contract value is the valve of the contract and its calculated as Contract value = lot size* futures price Minimum contract value Exchange has recommended that the minimum contract value of derivative contracts traded in the Indian markets should be pegged not below Rs. 2 Lakhs. Life of Derivatives The life of derivatives is limited and at any point of time there are three contracts available for trading-a near month (1 month), a mid month (2 month) and a far month (3month). The life of the derivative instruments of a particular month expires on the last. Thursday and if trading doesnt take place on that day then it is settled on the previous day. . Lot size Lot size refers to the number of underlying securities in one contract. Additionally, for stock specific derivative contracts SEBI has specified that the lot size of the underlying individual security should be in multiples of 100 and fractions, if any, should be rounded off to the next higher multiple of 100.

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Ex: If shares of XYZ Ltd are quoted at Rs. 1000 each and the minimum contract size is Rs. 2,00,000, then the lot size for the particular script stands to be 200000/1000=200 shares i.e. one contract in XYZ Ltd covers 200 shares.

OPERATIONAL TERMS USED Derivative: Derivatives are contracts whose value is derived from the price of something else typically cash market investments such as stocks, bonds, money market instrument or commodities.

1. Forward contract: A forward contract is a contract to buy or sell something in

future between two consenting parties. They decide the terms of the contract mutually and agree to fulfill the terms at a certain time in the future.

2. Future contract: Future contracts are same as above mentioned forward contracts.

But they are standardized contract in terms of price, quality, quantity delivery time and place for settlement up to a pre-determined date in the future. These contracts are traded in the exchange. If one of the parties now decide to move out of the contract he just sells it on the exchange to another party. Hence the problem of liquidity, which persists in the forward market does not exist in the future market.

3. Options contract: When u buy an option contract you are buying the right to

purchase or sell the underlying asset at a fixed price to a opposite party up to a predetermined date in the future. Option contracts are pre-defined and traded on the derivative exchange. underlying assets, There are two basic types of options: The call and the put These contracts trade on the basis of the price of the

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Buyer of the call options has the right to purchase underlying index or a share at a fixed price up to a fixed time in the future from the seller of the call option. The buyer of the put option has the sell the underlying index or share at a fixed price up to a fixed time in the future to the seller of the put option.

4. Swap: Swap is a contract where two parties agree their interest payment liabilities

on the agreed amount of each other debt, for a fixed time period.

5. Hedger: Hedger wish to eliminate or reduce the price risk to which they are already

exposed

6. Speculators: Speculators are those classes of investors who willing to take price

risk to profit from price changing in the underlying.

7. Arbitrager: Arbitrager profit from price differential existing in two markets by

simultaneously operating in two different markets.

Difference between derivatives and equity As we have understood derivatives derives its value from the underlying asset that could be equity or Index. Thereby buying derivatives instruments one gets a chance to play on the price changes in the underlying. On the other hand, equity is a share in the share capital of a company. Thus, by buying equity one gets a right to share the profits earned by the company. Owning shares entitles the investor to corporate actions such as dividends, bonus, stock-splits etc. This is not the case for derivatives.

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A person holding derivatives contracts is not eligible for any corporate action like dividends, bonus, stock-split etc.

All derivatives available on all stocks that trade on NSE Derivative instruments are available on certain stocks that satisfy the norms set by the exchange. Further, the derivatives instruments are available on 3 indices viz., Nifty, CNX IT and Bank Nifty, Currently, derivative instruments are available on 116 stocks and 3 indices on NSE. Arbitrage Arbitrage is simultaneous buying and selling of securities in two markets and making risk less profit. Arbitragers identify the opportunities (price difference of same script) that exist in different markets and make profit. Ex: A script of XYZ Ltd trading on BSE at 850 and trading on NSE at 865. Arbitragers buy at BSE and sell at NSE. Hedging Hedging is a tool used to minimize the risk by using futures and options. Basically hedging is done by people who possess the underlying asset and if they expect the price to fall then they cover their positions using the derivative instruments. In hedging we try to reduce the risk. Arbitrage allows investors to make risk-less profits on account of miss pricing Speculation Speculation involves the buying holding, and selling of stocks, commodities, futures, etc to profit from fluctuations in its price. Speculation adds liquidity to the market and they wish to bet on the future price of the asset. Derivatives can be used as a proxy for cash market trading

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Derivatives are used as proxy for cash market. For ex: if a investor is having a bullish view on a given underlying, then the investor can either buy the stock in cash market by paying the entire value or assume the same position in F&O by paying only a part of the amount which is required for buying shares in cash market. At the same time, a derivative investor would be in a position to enjoy the same profits as one would have been able to earn by buying the same number of shares in equity market. Thus, not only F&O can be used as a proxy for cash market trading but is also gives the investor the added advantage of leverage. Leverage Leverage given the investor advantage of holding high value by paying only a part of the total value in the form of margin. For ex: If one wants to buy 600 shares of Reliance @ 760/share, the investment required is Rs.4,56,000. On the other hand, a position of same value can be assumed by paying only Rs. 70,608 in futures. This money is called the Margin Money. Thus, the position is leveraged to the extent of Rs. 3,85,392 (45600070608) Short Selling An investor can go short for more than one day as derivatives allow carrying the position for the entire contract period. For e.g. one can short Reliance Futures/Options and hold the same till expiry. In a bearish scenario this feature provides the F&O traders a considerable advantage over the cash market traders who are compelled to close their short positions by the end of the trading session. Ownership of derivatives Unlike cash market one does not become the owner of the underlying. In derivatives the investor only gets a chance to bet on the price movement of the underlying. Thus the investor is entitled to only the profit earned or the loss incurred from the time of assuming the position till the closure of the same. Difference between settlement in cash and derivatives segment

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The difference between the cash market settlement and derivatives market settlement in that in cash market settlement, delivery of the stocks takes place and in case of derivatives it is all cash settled. So there is no question of delivery.

Market wide position limit Market wide position limit is being used by the exchange as a tool to control the maximum limit on the positions taken by members and clients. Market wide position limit on a particular underlying stock should be either lower of thirty times the average number of shares traded daily during the previous calendar month or twenty percent of the share held by the non-promoters in the relevant underlying security. FUTURES A standardized, exchange traded financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), the underlying instrument at a predetermined future date and price. Various types of futures There are two types of equity futures available. They are stock futures and index futures. These contracts derive their value from the value of the underlying index. Stock futures: futures contract is where the underlying is a stock. Ex: futures on SBI, ONGC etc. Index Futures: Futures contract where the underlying is an index i.e., the underlying asset is the index, are known as Index Futures Contracts. For example, futures contract on NIFTY Index. In case of futures market an investor pays a margin whereas, in case of cash market an investor has to pay the entire value.

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Margin Margin is the amount that an investor has to deposit with the broker upfront if he/she wants to take some positions in the future market. An investor has to pay initial margin and exposure margin. Margin is paid by the investors to cover for the loss made on his position. Margin is determined by the exchange on a day-to-day basis. The margin varies on a day-to-day basis depending on the price and volatility of the underlying. The margin does not vary whether it is near month contract or far month contract. The margin is same for both the buyer and seller. The margin is refundable but after adjusted for profit/loss. Ex: if the investor has purchased/sold march futures of XYZ ltd @ 850 by paying a margin of Rs.200000 and on the settlement date the cumulative profit/loss made is 5000 then the margin account is settled by given the difference ( in case of loss) or adding both (in case of profit). Holding of Position There is no compulsion to hold the position till maturity and can be squared off at any point of time before maturity if the target or desirable profit is reached. Actually profit or loss depends on the entry and exit points of the price but not the time at which investor enters or exits. Margin account The margin account cannot go below a certain level of the total margin paid known as maintenance margin. If the balance falls below then maintenance margin, the investor receives a margin call and is expected to top up the margin account with the difference to bring it back to the initial margin level before the trade commences on the next day. An investor can carry forward positions by rolling over before the expiry of the contract.

Rollover
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Rollover is the process of squaring up of an investment position before the expiry of current month and assuming the same and equivalent position in the next month contract. Positions are usually rolled over when one is holding an investment position which is not profitable by the expiry of the contract. Under such circumstances, the investor rolls over the position in anticipation of earning profits in the next contract month.

Factors that affect the future price The factors that affect the spot price also affect the future price. The various factors are the sentiments of the investor about the stock and whole market, the expectations about the results and cost of carrying.

Basis Basis is defined as the difference between spot and future price and there will be difference basis for each delivery month. In a normal market, basis will be positive. This indicates that future price generally exceeds spot price.

OPTIONS An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It also a binding contract with strictly defined terms and properties.

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Options are different from futures A future contract is a contract where both the buyer and a seller are under obligation towards the execution of the contract. In case of options it is the right but not the obligation for buyers of an option and obligation for writer of the option. American option An American option is the option which can be exercised at any point of time before the expiration date. All the stocks potions are American option European option A European option is the option that can be exercised only on the expiration date. All the index options are European options. Strike price The strike price of an option is the pre-determined price of the underlying asset at which it can be bought or sold if the option buyer exercises his right to buy/ sell on or before the expiration day. It is the price at which you have the right to buy/sell. In-the-money option A call option whose strike price is less than the spot price then it is said that the call option is in-the-money, means if the buyers of the call option executes their right then they make profit. A put option whose strike price is more than the spot price then it is said that the option is in-the-money, implies if the buyers of the put option executes their right then they make profit.

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At-the-money A call option whose strike price is equal to the spot price then it is said that the option is at-the-money and the buyers of the call option are at no profit/no loss if they execute their right. A put option whose strike price is equal to the spot price then it is said that the option is at-thwe-money and the buyers of the put option is at no profit/no loss if they executes their right. Out-of-money option A call option whose strike price is more than the spot price then it is said that the option is out-of-money and the buyers of the call option should leave the option go expire since they are in a loss making position. A put option whose strike price is less than the spot price then it is said that the option is out-of-money and the buyers of the put option should leave the option go expire since they are in a loss making position. Volatility Volatility is the rise or fall of a stock sharply in a set period. Volatility for an option means the fluctuations in the price of the underlying from the time the investor buys/sells an option and all till the expirations. Volatility is typically calculated by using variance or annualized standard deviation of the price or return. Highly volatile means that there are huge swings in a very short period.

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CHAPTER 5
ANALYSIS AND INTERPRETATION
STUDY ON STRATEGIES Naked strategies (futures and options) Derivative positions that are un-hedged against adverse market movements are called naked strategies (e.g. sole futures positions or sole option position). Naked strategies are the building blocks of other advanced and complex strategies. These are also the simplest to understand. Types of naked strategies are. Futures: Futures can be used as a proxy to cash market and it offers benefit of leverage. Maximum loss and profit in futures is unlimited. Short selling (selling without actually owing the stock futures) of stock futures/index futures is possible and the short position can be carried for a day to three months.

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5.1 LONG FUTURE A naked long futures position can be taken by the investor, if the investor is relatively confident that the underlying is likely to rise in the near term. As said above, a naked futures position is proxy to positions in spot market. Therefore the potential profit or loss is unlimited.

Buying Price as on 16th April 2009 0f Acc : 620 Days 1 2 3 4 5 6 Opening Prices 620 620 614 603 613 641 ClosingPrices 616 609 611 610 639 646 Mark to Market Profit/Loss -4 -11 -13 7 26 5

TABLEI NO:1

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GRAPH NO:1 ANALYSIS: If a investor buys at Rs620 cash market investors total profit after 6 days will be Rs 20. But in case of future investor get same amount of return with lessor investments i.e. by investing margin. INFERENCE: If the investor thinks that market is in bullish trend if he takes the long position in the future market he can make some profits.

5.2 SHORT FUTURE If stock is expected to move down in the near or medium term, short position in futures can be taken on the same to benefit in bearish phase. If market or stock moves as expected investor makes costless profit. Buying Prices 3rd march 2008 Acc: 880 Days 1 2 3 4 5 Opening Prices 880 870 880 800 820 ClosingPrices 868 878 800 822 825 Mark to Market Profit/Loss 12 -8 80 -22 -5
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827

800
TABLE NO:2

27

GRAPH NO:2

ANALYSIS: If a investor buys at 880 Rs in cash market investors total profit after 6 days will be Rs 84. But in case of future investor get same amount of return with lessor investments i.e. by investing margin. INFERENCE: If the investor thinks that market is in bearish trend if he takes the short position in the future market he can make some profits.

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5.3 LONG CALL Long call means investor will buy a call option. Long position in Call options can be taken if the outlook for the underlying stock is bullish and the stock price is expected to move above the strike price before expiry.

Exercise Price of Acc : 870 Rs Spot Price 800 820 840 860 880 Exercised/Not exercised Not exercised Not exercised Not exercised Not exercised Exercised Pay off of buyer in opt market -10 -10 -10 -10 0 Cash mkt Pro or loss -70 -50 -30 -10 10
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900 920

Exercised Exercised

20 40

30 50

TABLE NO:3

GRAPH NO:3 ANALYSIS: Investor buys 870 Call @10 Rs option premium. If an investor squares-off his position now, he will be in profit. If investor buys at Rs870 in cash market his maximum loss will be 70 Rs within given spot prices. But he can make a profit of Rs 50 if a price moves up. INFERENCE: In the first four levels loss is minimized in the option market, whereas loss is very high in the cash market. Hence long call option helps in hedging risk of price fluctuations at times where the price fall below Rs 870. Analysis of Current Example:

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Mr. Nataraj is bullish on Nifty on 17th March, when the Nifty is at 2757.45. He buys a call option with a strike price of Rs. 2600 at a premium of Rs.166.6, expiring on 26th March. If the Nifty goes above 2766.6, Mr. Nataraj will make a net profit (after deducting the premium) on exercising the option. In case the Nifty stays at or falls below 2600, he can forego the option (it will expire worthless) with a maximum loss of the premium. Date Spot Price 17/3/2009 2757.45 24/3/2009 2938.70

From Table it is observed that after 17th March market never behaved as per our expectation. In order to minimize the loss it is better to excise the option on 17th March, which will result in loss of (2938.70-2600-166.6) 100 = (17210). Interpretation: Action 1 Action 2 If you the excise the option 17th March your loss will be 17210 If you do not excise the option your loss will be 16660

5.4 SHORT CALL Short Call means seller of the Call option. If the market or the stock is expected to move in bearish phase or the upside is looking limited to the strike of the Call option, short position in Call option can be taken to benefit from the situation. Exercise Price: 900 Rs Spot Price 840 860 880 900 920 940 Exercised/Not exercised Not exercised Not exercised Not exercised Exercised Exercised Exercised Pay off of seller in opt market 10 10 10 10 -10 -30 Cash mkt Pro or loss 60 40 20 00 -20 -40
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960

Exercised -50 TABLE NO:4

-60

GRAPH NO:4

ANALYSIS: An investor will buy short Call at Rs 10 option price. If the investor decides to square-off his position he makes costless profit. Investor buys the stock at 900 and he will make the profit only if the market goes down. If the same stock goes up then his loss increases to 60 but in the options the loss will be only premium what he has paid. INFERENCE: When the market is bearish to take the advantage of the situation he can implement this strategy reduce his loss comparing to the cash market. Here he can take short position in call option. Analysis of Current Example: Mr. Bala is bearish about Nifty and expects it to fall. He sells a Call option with a strike price of Rs. 2600 at a premium of Rs. 29.55, when the current Nifty is at 17 march

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2552.84. If the Nifty stays at 2800 or below, the Call option will not be exercised by the buyer of the Call and Mr.Bala can retain the entire premium of Rs. 29.55.

Action 1 Action 2

If you the excise the option 17th March your profit will be 2955 If you the excise the option 24th Mach your loss will be 18700

5.5 LONG PUT Here an investor buys a put option. Long position in Put option can be taken if the forecasting for the underlying is bearish and is expected to move below the strike price before expiry. Exercise Price: 900 Spot Price 840 860 880 900 920 940 960 Exercised/Not exercised Profit/ Loss Cash Position 60 40 20 00 -20 -40 -60 Mkt

Not exercised 50 Not exercised 30 Not exercised 10 Exercised -10 Exercised -10 Exercised -10 Exercised -10 TABLE NO:5

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GRAPH NO:5

ANALYSIS: A investor will buy a put option @ Rs 10. If the investor decides to square-off his position he makes costless profit. But if investor invested in cash market his loss will be unlimited if prices moves up. INFERENCE: This strategy can be used when the market is expected to fall in the short term then he can make profits of the situation. Comparing to cash market investor can limit his loss only to premium, if market conditions are reverse. Analysis of Current Example:
Mr. Ajith is bearish on Nifty on 18th March, when the Nifty is at 2552.85. He buys a Put option with a strike price Rs. 2600 on 2nd March at a premium of Rs. 17.15, expiring on 26th March. If the Nifty goes below 2582.85, Mr. Ali will make a profit on exercising the option. In case the Nifty rises above 2600, he can forego the option (it will expire worthless) with a maximum loss of the premium

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Date Spot Price

2/3/2009 2674.6

18/3/2009 2552.85

24/3/2009 2938.70

From Table it is observed that after 2nd March market behaved as per our expectation. In order to maximize the profit it is better to excise the option on 18th March, Interpretation: Action 1 Action 2 If you the excise the option 18th March your profit will be 3000 If you the excise the option 24th March your loss will be 1750

5.6 SHORT PUT Short put means writing of put option. Short position in Put option can be taken if downside in the underlying is, expected to be limited and it is not expected to move below the strike price of option before expiry, if the premium on the Put depreciates enough, investor can square-off the position to get profit. Exercise piece: 890 Spot Price 840 860 880 900 920 940 960 Exercised/Not exercised Profit/ Loss Cash Position -60 -40 -20 00 20 40 60 Mkt

Not Exercise -50 Not Exercise -30 Not Exercise -10 Exercised 10 Exercised 10 Exercised 10 Exercised 10 TABLE NO:6

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GRAPH NO:6

ANALYSIS: Short position in Put option can be taken if downside in the underlying is, expected to be limited and it is not expected to move below the strike price of option before expiry. But if investor purchased at Rs 890 in cash market his maximum loss will be 60 Rs within given spot prices. But in options its restricted to Rs 10 only. INFERENCE: This strategy may help the investor to take the advantage of the situation. In cash market an investor will pay huge amount and he will take position but in the options an investor will pay premium and make more profits. If the market goes up also in option he will lose only premium. Analysis of Current Example: Ms. Raghu is bullish on Nifty when it is at 2757.45. She sells a Put option with a strike price of Rs. 2800 at a premium of Rs. 85.80 expiring on 26th March. If the Nifty index stays above 2800, She will gain the amount of premium as the Put buyer wont exercise his option. In case the Nifty falls below 2800, Put buyer will exercise the option and the Ms.
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Raghu will start losing money. If the Nifty falls below 2714.2, which is the breakeven point, Ms. Raghu will lose the premium and more depending on the extent of the fall in Nifty.

Date Spot Price

17/3/2009 2757.45

26/3/2009
3108.65

From above table it is observed that after 17 March market behaved as per our expectation. In order to Maximize the profit it is better to excise the option on 26th March, which will result in profit of 85.8 100 = Rs.8580.

Interpretation: Action 1 If you the excise the option 26th March your profit will be 8580

STRATEGIES: Strategies are the combinations that investors form by using futures and options in order to maximize their returns and minimize their losses. Strategies help investors to act according to their sentiments and achieve the targets set by investors. Some of the strategies are

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5.7 BEAR PUT SPREAD Investor applies the Bear Put strategy when he wants to hedge against the falling market. In Bear Put spread the investor purchases the higher strike put and sell lower strike put. Spot Price 2350 2375 2400 2425 2450 2475 2500 2525 2550 2575 2600 2625 Short Pre 20 20 20 20 20 20 20 20 20 20 20 20 Long Prm 30 30 30 30 30 30 30 30 30 30 30 30 long position 150 125 100 75 50 25 0 0 0 0 0 0 Short position -100 -75 -50 -25 0 0 0 0 0 0 0 0 Net position 40 40 40 40 40 15 -10 -10 -10 -10 -10 -10 Cash Pos -125 -100 -75 -50 -25 00 25 50 75 100 125 150

TABLE NO:7

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GRAPH NO:7 ANALYSIS: In Bear Put spread the investor purchases the higher strike put and sell lower strike put (2500&2450). It is helpful to the investor in the bearish market. He can take two positions at a time so that he can take advantage of the situation. If investor buys at Rs 2475 in cash market his maximum loss will be 125 Rs within given spot prices. But he can make a profit of Rs 150 if a price moves up. INFERENCE: In this strategy an investors loss is limited and profits are more as we see in the above table if the prices of the stock increases his profits also increase. But in case of cash both profit and loss are unlimited. Analysis of Current Example: Situation: On 5th April spot rate of Nifty is trading at 2052.55. You buy 1 Nifty April 2060 put at Rs 50 and sell 1 Nifty 2000 put at Rs 20. Maximum profit is Rs 3000 and maximum loss Rs 3000.

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Date Spot Price

11/4/2005 2008

13/4/2005 2025.45

27/4/2005 1970

From Table it is observed that after 11tht April market behaved as per our expectation. In order to Maximize the profit it is better to excise the option on 27th April, which will result in profit of (2060-2000-30) 100 = Rs.3000. Interpretation: Action 1 Action 2 If you the excise the option 27th April your profit will be 3000 If you the excise the option 13th April your profit will be 455

5.8 BULL PUT SPREAD


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An investor who is moderately bullish uses Bull Put strategy. This strategy entails selling put option with a higher strike and buying put option with a lower strike. Spot Price 2350 2375 2400 2425 2450 2475 2500 2525 2550 2575 2600 2625 Short Premium 20 20 20 20 20 20 20 20 20 20 20 20 Long Premium 10 10 10 10 10 10 10 10 10 10 10 10 Long Position 90 65 40 15 -10 -10 -10 -10 -10 -10 -10 -10 Short position -130 -105 -80 -55 -30 -5 20 20 20 20 20 20 Net Position -40 -40 -40 -40 -40 -15 10 10 10 10 10 10 Cash Pos -125 -100 -75 -50 -25 00 25 50 75 100 125 150

TABLE NO:8

GRAPH NO:8

ANALYSIS:

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This strategy entails selling put option with a higher strike and buying put option with a lower strike. He will sell the put option at high strike price @ 2500 and he buys the same put option at the lower strike @ 2450. In cash we cant take more than one position at a time but option it is possible. Suppose investor buys at Rs 2475 in cash market, his maximum loss will be Rs 125.

INFERENCE: This strategy is helpful in the bullish market. An investors loss is limited and profits will be more by implementing this strategy. By using this strategy the maximum loss is 40 and the maximum profit is limited to Rs 10. But in cash market an investors maximum loss is 125 Rs.

5.9 LONG STRADDLE A long straddle involves buying a Call and Put option of the same of strike and time to expiration. The strategy would make unlimited profits beyond the break even points. However, within the breakeven points the strategy would make constant losses. The advantage of the strategy lies in the fact that the loss potential is limited to the cost of premium paid. The payoff diagram for the strategy is as shown below: Spot Price 2950 3050 3150 3250 3350 3450 3550 3650 3750 Call Prm 55 55 55 55 55 55 55 55 55 Put Prm 60 60 60 60 60 60 60 60 60 Call Pos 345 245 145 45 -55 -55 -55 -55 -55 Put Pos -60 -60 -60 -60 -60 40 140 240 340 Net pos 285 185 85 -15 -115 -15 85 185 285 Cash Pos -400 -300 -200 -100 000 100 200 300 400
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TABLE NO:9

GRAPH NO:9 ANALYSIS: An investor buys Call and Put option at 3350 with a premium of Rs.55 and Rs.60 respectively. The strategy breaks even a 3240 (3350-110) levels on the lower side 3460 (3350+110) levels on the upper side. Beyond the breakeven points, the strategy would make unlimited profits. However, within the breakeven points, the strategy would make constant losses. The maximum loss for the strategy is limited to the sum of premiums paid i.e. Rs.110 (50+60). To achieve the target levels, the strategy was left till expiry of the contact. Eventually, the 3350 Put option was expired out-of-the-money and the 3350 Call option closed in-the money. Suppose investor buys at Rs 3350 in cash market, investors maximum loss in cash market is Rs 400 within given spot prices and maximum profit is Rs 400 in cash market.

INFERENCE: When the market is very much volatile this strategy is implemented. Beyond the breakeven points, the strategy would make unlimited profits. However, within the
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breakeven points, the strategy would make constant losses. Comparing to cash market, even though investor earns lesser profit, investors loss will be limited to Rs 115. Analysis of Current Example: Situation: on 19th April Buy 1 Nifty Apr 1910 call at Rs 20 and Buy 1 Nifty Apr 1910 put at 15.Upside breakeven = 1945(Excise Price 1910 + net debit 35) Downside breakeven = 1875(Excise Price 1910 net debit 35)

Profit is unlimited; loss potential is limited, maximum loss Rs 3500. Date Spot Price 19/4/2005 1909.4 25/4/2005 1970.95

From Table it is observed that after 19th April market behaved as per our expectation. In order to Maximize the profit it is better to excise the option on 25th April, which will result in profit of (1970.95-1945) 100 = Rs.2595.

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Analysis of Derivative Strategies under different market conditions

5.10 SHORT STRADDLE When a stock is expected to move in a particular range, short straddle strategy can be adopted. A short straddle involves selling a call and put option of the same strike price and same expiry month. Investors would make profits only if the stock moved in the range of break even points and is limited to the sum of premiums received. Therefore, investors are advised to hold such kind of a strategy with appropriate stop loss. The pay off diagram for the strategy is as shown below:

Spot Price 3210 3270 3330 3390 3450 3510 3570 3630

Call Prm 40 40 40 40 40 40 40 40

Put Prm 50 50 50 50 50 50 50 50

Call Pos -200 -140 -80 -20 40 40 40 40

Put Pos 50 50 50 50 50 -10 -70 -130

Net Pos -150 -90 -30 30 90 30 -30 -90

Cash Pos -240 -180 -120 -60 00 60 120 180


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Analysis of Derivative Strategies under different market conditions

3690

40

50

40

-190

-150

240

TABLE NO:10

GRAPH NO:10 ANALYSIS: It was observed that a stock moved in a wide range of 3000 and 3600 levels. Hence, to capture this opportunity, Call and Put option were sold at 3450 for a premium of Rs.40 and Rs.50 respectively. The lower break even for the strategy is 3360 (3350-90) and the upper break even for the strategy is 3540 (3350+90) levels. Within this range the strategy would make maximum profit of Rs.90. Suppose investor invests in cash market investor will incur huge loss if market falls. But his profit will be more if market moves up in cash market. But while using this strategy, investor assumed that prices moves within a particular range in which his profit in option will more than cash market. INFERENCE: Beyond the break even points the strategy would make unlimited loss. Hence the strategy is to be held with an appropriate stop loss of 3330 on the lower levels and 3570

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Analysis of Derivative Strategies under different market conditions

1evels on the upper side. Comparing to cash market, investor can minimize his loss, if market conditions are reverse.

Analysis of Current Example: Situation: on 20th April sell 1 Nifty Apr 1910 call at Rs 20 and sell 1 Nifty Apr 1910 Put at 15. Upside breakeven = 1945(excise price 1910 + net credit 35) Upside breakeven = 1875 (excise price 1910 - net credit 35) Maximum profit is 3500, maximum loss unlimited. Date Spot Price 11/4/2005 2008 13/4/2005 2025.45 27/4/2005 1970

From Table it is observed that after 11th April market never behaved as per our expectation. In order to Maximize the profit it is better to excise the option on 13th April, which will result in profit of (2040-2025.45) 100 = Rs.1455 Interpretation: Action 1 Action 2 If you the excise the option 13th April your profit will be 1455 If you the excise the option 27th April you will be no loss no gain

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Analysis of Derivative Strategies under different market conditions

5.11 LONG STRANGLE Another strategy to adopt in a volatile scenario is long Strangle. A long strangle is similar to a long straddle but the difference is that the strike of the Call and Put are different. The advantage of the strategy lies in the fact that the loss potential is limited to the cost of premium paid where as the profit potential is unlimited. The strategy would make unlimited profit beyond the breakeven points. However, within the break even points investors would be incurring a continuous loss equal to the amount of premium paid.

Spot Price 2850 2950 3050 3150 3250 3350 3450 3550 3650

Call Prm 80 80 80 80 80 80 80 80 80

Put Prm 40 40 40 40 40 40 40 40 40

Put Pos 310 210 110 10 -40 -40 -40 -40 -40

Call Pos -80 -80 -80 -80 -80 -30 70 170 270

Net Pos 230 130 30 -70 -120 -70 30 130 230

Cash Pos -400 -300 -200 -100 000 100 200 300 400

TABLE NO:11

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GRAPH NO:11 ANALYSIS: In order to gain from the volatile movement, a long strangle was created towards the end of the contract. For the purpose, a 3300 Call option and 3200 Put option were bought for a premium of Rs. 80.00 and Rs.40.00 respectively. The total cost of the strategy was Rs.120. The break even for the strategy would be placed at 3080 levels on the lower side and 3380 levels on the upper side. Suppose investor buys at Rs 3350 in cash market, investors maximum loss in cash market is Rs 400 within given spot pricesand maximum profit is Rs 400 in cash market. INFERENCE: Beyond the break even points, the strategy will make continuous profits. However, within the breakeven points, the strategy will incur maximum losses of Rs.120.

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Analysis of Derivative Strategies under different market conditions

Analysis of Current Example: Situation: on 11th April 05 share of Nifty is currently standing at 2008 Buy 1 Nifty Apr 2030 call at Rs. 30, buy 1april 2000 put at Rs 25. Upside breakeven = 2085 (Exercise price 2030 + net debit 55)

Downside breakeven = 1945 (2000 - 55 net debit) Date Spot Price 11/4/2005 2008 13/4/2005 2025.45 19/4/2005 1909.4

From Table it is observed that after 11th April market behaved as per our expectation. In order to Maximize the profit it is better to excise the option on 19th April, which will result in profit of (2000-55-1909.4) 100 = Rs.3560 Interpretation: Action 1 Action 2 If you the excise the option 19th April your profit will be 3560 If you the excise the option 13th April your loss will be 5500

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Analysis of Derivative Strategies under different market conditions

5.12 SHORT STRANGLE When the stock is expected to move in a particular range; investors can capitalize this opportunity by selling a Call s and Put option of different strike prices but same expiry period. Investors would gain only if the stock moved within the range of break even points. Investors would be advised to hold this kind is of strategy with an appropriate stop loss. The only limitation of the strategy is that the Profit potential is restricted to the sum of the premium received. The payoff diagram for the strategy is as shown below Spot Price 165 175 185 195 205 215 225 235 245 Call Prm 10 10 10 10 10 10 10 10 10 Put Prm 5 5 5 5 5 5 5 5 5 Call Pos 10 10 10 10 10 10 5 -5 -15 Put Pos -20 -10 0 5 5 5 5 5 5 Net Pos -10 0 10 15 15 15 10 0 -10 Cash Pos -40 -30 -20 -10 00 10 20 30 40

TABLE NO:12

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Analysis of Derivative Strategies under different market conditions

GRAPH NO:12 ANALYSIS: Stock steadily moved in a range of 40 points i.e. 180-220 levels. Hence, to capture this opportunity a Short Strangle was created, here, Call option was sold at 220 to benefit from limited upside movement in the stock and Put option was sold at 190 in order to gain from the limited downside movement in the stock for a premium of Rs.10 and 5 respectively. Hence, the maximum profit for the investor will be limited to the sum of premiums received i.e. Rs.15 (10+5). Any stock movement above/below the 220/ 190 levels would lead to unlimited loss. Suppose if investor buys at Rs 205 in cash market his maximum loss will be 40 Rs within given spot prices. But he can make a profit of Rs 40 if a price moves up. But while selecting this strategy it is assumed that prices will be in the range from 175 to 235. At these levels his profit or loss is 30 Rs in cash market. INFERENCE: This strategy is helpful in volatile market. By using this strategy profit is made by selling a call option and put option. By adopting this strategy investor can reduce his loss by 30 Rs, if prices traded in the range of 175 to 235.

Analysis of Current Example: Situation: on 11th April 05 share of Nifty is currently standing at 2008 sell 1 Nifty Apr 2030 call at Rs 30, sell 1 April 2000 put at Rs 25 Upside breakeven = 2085 (Exercise price 2030 + net debit 55)

Downside breakeven = 1945 (2000 - 55 net debit) Date Spot Price 11/4/2005 2008 13/4/2005 2025.45 19/4/2005 1909.4

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Analysis of Derivative Strategies under different market conditions

From Table it is observed that after 11th April market behaved as per our expectation. In order to Maximize the profit it is better to excise the option on 13th April, which will result in profit of 55 100 = 5500 Interpretation: Action 1 Action 2 If you the excise the option 13th April your profit will be 5500 If you the excise the option 19th April your loss will be 3560

CHAPTER6 FINDINGS
An investor can use long future if market is bullish in short period. It will give same profit with less investment compare to cash market. An investor may use short future if market is bearish in short period.
When the market is bearish to take the advantage of the situation one can

implement this strategy reduce his loss comparing to the cash market. Here one can take short position in call option
Long put option can be taken if the underlying stock is bearish and expected to

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move below strike price.


Investor applies bear put strategy when he wants to hedge against falling market.

An investor who is moderately bullish uses bull put strategy. The long straddle strategy would make unlimited profits beyond the break even points. However, within breakeven points the strategy would make constant losses.
Long strangle is used when the market is very much volatile. In Long Straddle, at expiry, the investor will make profits if the share price has

moved strongly enough in either direction. Profit is unlimited; loss potential is limited.
In Short Straddle, at expiry, the investor will make profits if the share price remains

steady. The maximum profit is limited, maximum loss unlimited.

CHAPTER 7 CONCLUSSION
Strategies we can conclude that during bullish market outlook Long Call, Short Put, Bull Spread and Long Strangle strategies are suitable to use. The Long Put, Short Call and Bear Spread are best suited during bearish market condition. When you expect market to be neutral for few forth coming days, it is better to hold on to Short Strangle strategies. When uncertainty about market is more it is wise to use straddle strategies. The study shows that derivative strategies can be used under different market conditions and profits can be maximized and loss can be minimized by using derivative

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strategies. Comparing to cash market trading derivatives trading gives more profit. Sometimes it minimizes the losses also. Derivative can be used as hedging tool against the risk.

CHAPTER 8 SUGGESTIONS
Investor can diverse their risk by using derivative strategy. It will ensure guaranteed profit to investor. Derivatives plays a major role in economy, so the domestic investor should take a step into derivatives market Investor may use derivative strategies as hedging tool against the losses. Investors can use derivatives to hedge their naked position in cash market. To safe guard their positions from unexpected movements investor should use derivatives.

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Analysis of Derivative Strategies under different market conditions

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