STUDY ON DERIVATIVES AND APPLICATION OF FUTURE AND OPTION AS HEDGING TOOLS

CONTENTS
INTRODUCTION OBJECTIVE OF STUDY METHODOLOGY INDUSTRY PROFILE COMPANY PROFILE DERIVATIVES AND ITS TYPES ANALYSIS CONCLUSION

INTRODUCTION

Considering the current volatility in the economy and subsequently in the stock markets due to complexity created by multiple macro-economic variables and growing international trade, the role of Financial Derivatives is increasingly becoming more and more important.

Then in this project we proceed with understanding the different types of derivatives commonly found and prevalent in India. This study would include understanding the risks and characteristics associated with each of these derivatives. A wide variety of literature has been read and reviewed through various mediums so as to understand the above mentioned aspects of the project.

OBJECTIVE OF STUDY

To understand the nature and working of derivatives and its various types.

To understand the scope of the Indian market for derivatives.

To understand the need and usefulness for using futures and options as a hedging tool .

METHODOLOGY

INDUSRTY PROFILE

Stock exchange is that place where trading of shares is done in terms of sale and purchase.

There are 23 stock exchanges in the India. Mumbai's (earlier known as Bombay), Bombay Stock Exchange is the largest, with over 6,000 stocks listed. The BSE accounts for over two thirds of the total trading volume in the country. Established in 1875, the exchange is also the oldest in Asia. Among the twenty-two Stock Exchanges recognized by the Government of India under the Securities Contracts (Regulation) Act, 1956, it was the first one to be recognized and it is the only one that had the privilege of getting permanent recognition ab-initio.

Name of Indian stock exchange

1.Bombay stock exchange 2.national stock exchange(Mumbai) 3.Banglore stock exchange 4.Utter Pradesh stock exchange (Kanpur) 5.Magadh stock exchange(Patna) 6.Ahmedabad stock exchange 7.vadodara stock exchange(Baroda) 8.Bhubaneswar stock exchange 9.Calcutta stock exchange(kolkata) 10.madras stock exchange

Conti

11.Cochin stock exchange 12.coimbatore stock exchange 13.Gauhati stock exchange 14.Hydrabad stock exchange 15.Madhya Pradesh stock exchange(Indore) 16.Jaipur stock exchange 17.Ludhina stock exchange 18.Mangalore stock exchange 19.Pune stock exchange 20.saurashtrakutch stock exchange

NSE
The National Stock Exchange (NSE), located in Bombay, is India's first debt market. It was set up in 1993 to encourage stock exchange reform through system modernization and competition. It opened for trading in mid-1994. It was recently accorded recognition as a stock exchange by the Department of Company Affairs. The instruments traded are, treasury bills, government security and bonds issued by public sector companies

BSE
Bombay Stock Exchange is the oldest stock exchange in Asia What is now popularly known as the BSE was established as "The Native Share & Stock Brokers' Association" in 1875. Today, BSE is the world's number 1 exchange in the world in terms of the number of listed companies (over 4900) . BSE is the first exchange in India and the second in the world to obtain an ISO 9001:2000 certification. The BSE Index, SENSEX, is India's first and most popular Stock Market benchmark index.

COMPANY PROFILE
PROFILE OF THE COMPANY Name of the company : INDIABULLS SECURITIES LTD. Year of Establishment : 2000 Headquarter : Indiabulls Finance Centre, Tower 1, 8th Floor , Elphinstone Mills, Senapati Bapat Marg, Mumbai-400013 Nature of Business : Broking services Services : Online IPOs, Trading, Equity Research, Number of Employees : Over 2000 Customers : Greater than 6lakhs Website : www.indiabulls.com Slogan : Creating a world of smart investors

PRODUCTS AND SERVICES OFINDIABULLS SECURITIES LIMITED

Power Indiabulls

Depository Services

Indiabulls Signature Account

NRI Trading

Indiabulls Equity Analysis

DERIVATIVES

A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes.

TYPES OF DERIVATIVES

FORWARDS OPTIONS FUTURES SWAPS

TYPES OF OPTIONS

PUT OPTION: Break-Even Point = Strike Price + Premium

CALL OPTION: The break-even for a put option is: Break Even Point = Strike Price Premium

DIFFRENCE BETWEEN FUTURES AND OPTIONS

OPTIONS FUTURES

Exchange traded, with innovation. Same as futures Exchange defines the product Price is zero, strike price moves Price is zero Linear payoff Both long and short at risk Same as futures Strike moves. Price is always positive. Nonlinear payoff. Only short at risk. price is fixed, price

TERMINOLOGY OF DERIVATIVES

SPOT PRICE (ST) FORWARDPRICE (or) FUTURE PRICE(F) STRIKE PRICE(K):

EXPIRATION DATE

CONTRACT SIZE

USE OF DERIVATIVES

RISK MANAGEMENT

MARKET EFFICIENCY

HEDGING

COMPANIES DATA ANALYSIS

1.Mr. A has taken a long position in Reliance 1000 @ 987.70 expecting a bullish trend but he is not clear as market is uncertain..
0 -10000 -20000 -30000 -40000 -50000 -60000 -70000 -80000 -90000 -100000 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Series1

ANALYSIS

As on 27th APRIL, 2011 the amount invested in the shares of RELIANCE was Rs.987700 by purchasing the 1000 of shares at Last price of RS.987.7 But on 26th may the price of the shares of the company fell down to Rs. 931 Thus by selling the shares after holding it till 26th may ,the total loss of Rs. -56400 was observed.

Now Mr. A can hedge his long position of cash mkt by taking a short position in futures. Short position means sell first by later, it is used when market is bearish
90000 80000 70000 60000 50000 40000 30000 20000 10000 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Series1

ANALYSIS: Enter into short future on 26th May at Rs. 988 we may reduce the loss Rs56400 from to 54250 that is2150

2. Mr. A has taken a long position in Wipro 1000 @ 463.15 expecting a bullish trend but he is not clear now as market is uncertain.

5000

0 1 -5000 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

-10000

-15000

Series1

-20000

-25000

-30000

-35000

ANALYSIS:

As on27th APRIL,2011 the amount invested in the shares of WIPRO was Rs .463150 by purchasing the 1000 of shares at Last price of RS.463.15. But on 26th may the price of the shares of the company fell down to Rs. 447.35. Thus by selling the shares after holding it till 26th may ,the total loss of Rs. -15800 was observed.

Hedging
Now Mr. A can hedge his long position of cash market by taking a short position in futures.
18000 16000 14000 12000 10000 8000 6000 4000 2000 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Series1

Enter into short future on 26th May at Rs. 466.25 we may reduce the loss Rs.-15800 from to 18700 that is 2900

CONCLUSION

Using the options and futures as a hedging tools we can minimize the loss to some extent but the profit is not guaranteed. Hedging can be used to reduce risks.

Hedging is not speculation to get benefited from it and it does not work always.