Derivative Trading India

7/31/2019 Derivative Trading India

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DERIVATIVE TRADING INDIA

Never put all eggs in a single

basket21-Aug-12 [email protected]


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CONTENTS

Introduction

Development of Derivative market

About Derivative Features & Uses

Risk & Rewards

Challenges Questions & Answers

21-Aug-12 [email protected]


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Derivative market in India

SEBI set up a committee in 1996 to develop

appropriate regulatory framework for derivatives

trading in India. SEBI constituted another group in June 1998

under the Chairmanship of Prof. J. R. Verma & L.C.

Gupta to recommend measures for risk

containment in the derivatives market.

Derivatives trading on the Exchange commenced

on June 12, 2000.21-Aug-12 [email protected]


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Developments in the derivative

market have been around for as long as the people have

been trading with one another.

a group of Chicago businessmen formed theChicago Board of Trade (CBOT) in 1848.

The first stock index futures contract was trades

at Kansas City Board of Trade. Currently the most

popular futures contract in the world is based on

S&P 500 index, traded on Chicago Mercantile

Exchange.



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Derivatives in India

The futures contract at NSE is based onS&P CNX Nifty # Index.

It has a maximum of 3-month expirationcycle.

Three contracts are available for trading

I.e. with 1 month, 2 months and 3months expiry.



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B. Size of Derivative Exchanges

0

100

200

300

400

500

600

700

800

900

millioncontracts

Eurex Euronext CME CBOE CBOT AMEX

Top-8 Derivative Exchanges (volume)

KSE: 855m (2001) ; 1930m (2002)Value $1,800 bn (#5)

KSE BM&F

BM&F: 101m (2002)Value $3,200 bn (#4)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,0008,000

9,000

CMES&P500

EurexDAX

CMENasdaq

EurexSTOXX

EuronextCAC40

EuronextFTSE

OsakaNikkei

Top-8 Equity Index Futures (value)

billionUS$

KSEKOSPI

KSE:market-cap $216 bn (#14 ; 10% Tokyo, 60% Sydney)Cash trading $593 bn (#12 ; 40% Tokyo, 200% Sydney)

Futures trading $1680 bn (#3 ; 200% Nikkei)

0

20

40

60

80

100

120

140

160

180

millioncontracts

CMEEuro$

EuronextEuribor

EuronextSterling

SGXEuro$

KOFEXKTB

MexderInterest

Top-8 Interest Rate Futures (volume)

BM&FDI-future

BM&F: DI-futures 44m (2001) ; 71m (2002)

Value $1,180 bn (DI) + $680 bn (DDI)

+ $850 bn (US$ futures)

Brazil: government dom debt $180 bn

BM&FDDI-$

0

100

200

300

400

500

600700

800

900

billionUS$

BM&FUS$

CMEEuro

CMEYen

CMECHF

CMECAD

CMEGBP

CMEMXP

Top-8 Currency Futures Exchanges (value)

Sources: FIBV (2001) ; KSE, KOFEX, BM&F (2002)

KOFEXUS$

KOFEX: $75 bn USD futures trading (#7)

KTB futures trading $1,120 bn (#6) + OTCKTB cash trading $39 bn (Israel, Ireland)

Korea: government dom debt $100 bn


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Derivatives are financial contracts of pre-

determined fixed duration, whose values are

derived from the value of an underlying

primary financial instrument, commodity or

index, such as: interest rates, exchange rates,

commodities, and equities

What is a derivative



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Features of derivatives

Derivatives are contracts that have no

independent value

They derive their value from theirunderlying assets

They are used as risk shifting or hedging

instruments



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Uses of Derivatives

To hedge or insure risks; i.e., shift risk.

To reflect a view on the future direction of the market,

i.e., to speculate.

To lock in an arbitrage profit To change the nature of an asset or liability.

To change the nature of an investment without incurring

the costs of selling one portfolio and buying another.



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Common financial derivatives

forward contracts

futures

options

swaps



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Players in the derivative market (1)

Hedgers:

Hedgers face risk associated with the price

of an asset. They use futures or options

markets to reduce or eliminate this risk.



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Speculators :

They are people who wish to bet on future

movements in the price of the asset. Futureand Options contracts can give them an

extra leverage; that is, they can increase

both the potential gains and losses in aspeculative venture.




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Arbitrageurs:

Arbitrageurs are in business to take

advantage of a discrepancy between pricesin two different markets. For eg. If they see

the futures price of an asset getting out of

line with the cash price, they will takeoffsetting positions in the two markets to

lock in a profit.



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B. Size of Derivative Exchanges

0

100

200

300

400

500

600

700

800

900

millioncontracts

Eurex Euronext CME CBOE CBOT AMEX

Top-8 Derivative Exchanges (volume)

KSE: 855m (2001) ; 1930m (2002)Value $1,800 bn (#5)

KSE BM&F

BM&F: 101m (2002)Value $3,200 bn (#4)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

CMES&P500

EurexDAX

CMENasdaq

EurexSTOXX

EuronextCAC40

EuronextFTSE

OsakaNikkei

Top-8 Equity Index Futures (value)

billionUS$

KSEKOSPI

KSE:market-cap $216 bn (#14 ; 10% Tokyo, 60% Sydney)Cash trading $593 bn (#12 ; 40% Tokyo, 200% Sydney)

Futures trading $1680 bn (#3 ; 200% Nikkei)

0

20

40

60

80

100

120

140

160

180

millioncontracts

CMEEuro$

EuronextEuribor

EuronextSterling

SGXEuro$

KOFEXKTB

MexderInterest

Top-8 Interest Rate Futures (volume)

BM&FDI-future

BM&F: DI-futures 44m (2001) ; 71m (2002)

Value $1,180 bn (DI) + $680 bn (DDI)

+ $850 bn (US$ futures)

Brazil: government dom debt $180 bn

BM&FDDI-$

0

100

200

300

400

500

600

700

800

900

billionUS$

BM&FUS$

CMEEuro

CMEYen

CMECHF

CMECAD

CMEGBP

CMEMXP

Top-8 Currency Futures Exchanges (value)

Sources: FIBV (2001) ; KSE, KOFEX, BM&F (2002)

KOFEXUS$

KOFEX: $75 bn USD futures trading (#7)

KTB futures trading $1,120 bn (#6) + OTCKTB cash trading $39 bn (Israel, Ireland)

Korea: government dom debt $100 bn



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F. Future challenges1. Official regulation of rapidly expanding OTC derivative markets may need to be

aligned across institutions to limit arbitrage and enhance transparency.

2. Prudential supervision of off-balance sheet exposure may need to be

strengthened with reporting requirements and systemic risk analysis.

3. Derivatives exposure data may need to be considered in order to accurately

assess BOP and reserve positions.

4. Proper valuation and full disclosure (strong IAS39) may reveal solvency issues offinancial institutions.

5. Capital requirements for derivatives may need to be enhanced to limit regulatory

arbitrage and leverage.

6. Derivatives as zero-sum risk-transfer tools may create conflict with managed FX

and credit policies.7. Derivatives driven by distortionary taxation and weak underlying issues may

substitute for cash markets.

8. Management ofcounter-party risk may need to be enhanced (ISDA master,

central clearing and counterparty).

9. Margin systems could be tightened for leveraged members (dynamic, insurance).21-Aug-12 [email protected]


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Private

Banks

Financial

Institutions

Others

Public

Sector

Banks

ForeignBanks



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Questions & solutions



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Q:1

In Nov 1996, government led L. C. Gupta

Committee helped develop regulatory

framework for derivatives trading in India byrecommending derivatives to be declared as

securities. This helped catalyze

entrepreneurial activity and transfer risks from

risk adverse people to risk oriented people.



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Again the J.R.Verma committee

recommendations to develop settlement and

risk management systems for derivatives

including upfront margins, daily settlement,

online surveillance and position monitoring

and risk management marked a newdevelopment. These structural changes in the

equity derivative market made it organized

and transparent.



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Risk factor in Derivatives

More leverage

Less transparency

Dubious accounting

(not reliable)Regulatory arbitrage

Rising CP exposure

Hidden systemic risk

Tail-risk future exposure

Weak capital requirements

21-Aug-12 [email protected] 20


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Q:2

Problems evolve after introduction of

derivative:

Leverage of economy debt

Credit risk large notional value

Intrest rate risk

Also attribute increasedvolatility to highlyspeculative and levered participants.



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Lack of knowledge among investors

Absence of sound infrastructure

Technology limits



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YES it should have been introduced, some

rewards are:

Market efficiency

Risk sharing and transfer

Low transaction costs

Capital intermediation

Liquidity enhancement

Price discovery

Cash market development

Hedging tools

Regulatory savings

21-Aug-12 [email protected] 23


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Q:3

Issues which need to be addressed for acceleratinggrowth of derivative market are:

If any loss arises from derivative trading it would betreated as speculative loss and will be set off onlyagainst speculative income.

(Note: Income arises from derivative trading shouldbe treated same as capital gain/loss)

Retail investors were having lots of myths andmisconceptions about derivative trading .

The contract size was fixed at Rs 0.2 mn and it wasfixed in order to curb too much speculation from smallinvestor who had little knowledge about derivatives.



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According to me the measures taken by RBI,SEBIand stock exchange are adequate.

the other measures which can be taken are :

To make the investors more and more awareabout derivatives trading and also telling them

that this is safe for them to invest their money There must be proper arrangements which need

to be made for doing trading in derivative market.

There must be some tax regulations i.e if anindividual earns more profit then the limit whichis fixed by the government then he /she shouldneed to pay a fix amount of tax also.



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Thanks for being patience


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Derivative Trading India

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