A SUMMER INTERNSHIP PROJECT ON “A STUDY TO GUIDE INVESTORS ON DERIVATIVE MARKET ” SUBMITTED BY MD SAZAD MBA 3 rd Semester BPUT Reg No. 1406280048 UNDER THE GUIDANCE OF COMPANY GUIDE FACAULTY GUIDE SUDHANSHU KUMAR PARIDA KHSITISH KUMAR MAHAPATRA BRANCH HEAD LECTURER OF MBA DEPARTMENT RELIANCE SECURITIES Project Report submitted to “NIIS INSTIUTE OF BUSINESS ADMINISTRATION” in partial fulfillment of the requirements of III Semester MBA examinations of BPUT, ODISHA - 2015-2016
Transcript
A SUMMER INTERNSHIP PROJECT
ON
“A STUDY TO GUIDE INVESTORS ON DERIVATIVE MARKET ”
SUBMITTED BYMD SAZAD
MBA 3rd SemesterBPUT Reg No. 1406280048
UNDER THE GUIDANCE OF
COMPANY GUIDE FACAULTY GUIDESUDHANSHU KUMAR PARIDA KHSITISH KUMAR MAHAPATRABRANCH HEAD LECTURER OF MBA DEPARTMENTRELIANCE SECURITIES Project Report submitted to “NIIS INSTIUTE OF BUSINESS ADMINISTRATION” in partial fulfillment of the requirements of III Semester MBA examinations of BPUT, ODISHA - 2015-2016
NIIS INSTITUTE OF BUSINESS ADMINISTRATIONSARADA VIHAR,MADANPUR, Bhubaneswar -752054
1.1 INTRODUCTION1.2 NEED OF THE STUDY1.3 OBJECTIVES OF THE STUDY
1.4 RESEARCH METHODOLOGY1.5 LIMITATION OF THE STUDY
2
2.1 COMPANY PROFILE2.2 CHAIRMAN’S PROFILE2.3 PRODUCTS OF RELIANCE MONEY2.4 SWOT ANALYSIS OF RELIANCE MONEY
3
DERIVATIVE3.1 INTRODUCTION TO DERIVATIVES3.2 HISTORY & EVOLUTION3.3 PRODUCTS IN DERIVATIVE MARKET3.4 MARKET PARTICIPANT
4 INDEX4.1 INTRODUCTION TO INDEX4.2 SIGNIFICANCE OF INTEX
5
FUTURES & FORWARDS5.1 FUTURE PAYOFFS
6
OPTIONS & SWAPS6.1 OPTIONS PAYOFF6.2 OPTIONS STRATEGIES6.3 BASIC OF SWAPS
7 DATA ANALYSIS & INTERPRETATION
8 FINDINGS
9 SUGGESTIONS
10 CONCLUSION
CHAPTER-1
1.1 INTRODUCTION
Derivatives have been associated with a number of high-profile corporate events that roiled the global financial markets over the past two decades. To some critics, derivatives have played an important role in the near collapses or bankruptcies of Barings Bank in 1995, Long-term Capital Management in 1998, Enron in 2001, Lehman Brothers in and American International Group (AIG) in 2008. Warren Buffet even viewed derivatives as time bombs for the economic system and called them financial weapons of mass destruction (Berkshire Hathaway Inc (2002)
But derivatives, if “properly” handled, can bring substantial economic benefits. These instruments help economic agents to improve their management of market and credit risks. They also foster financial innovation and market developments, increasing the market resilience to shocks. The main challenge to policymakers is to ensure that derivatives transactions being properly traded and prudently supervised. This entails designing regulations and rules that aim to prevent the excessive risk-taking of market participants while not slowing the financial innovation aspect. And it also calls for improved data quantity and quality to enhance the understanding of derivatives markets.
1.2 NEED OF THE STUDY:-
A vigorous research is need to make a valuable contributions to wisdom through integrating with review of literature and methodology developed for the understanding and resolution of management problem and empirical training done there in .
On the other hand it’s more important this study is required to meet the partial fulfilment of the award of the degree i.e., Master of Business Administration from BPUT University.
The purpose of summer project report is, it allowed to complete the within a coherent, organised framework which is also standardised.
The project study is necessary to enhance our understanding and clarity of the subject, the context of the managerial problem and research problem
1.3 OBJECTIVES OF THE STUDY:-
To find out the factors for growth of derivative market segment as compared to cash segment in recent past era
To know the different risks involved in derivative segment To know how should futures options be valued and hedged To find out market sentiments towards the use of derivative product
1.4 RESEARCH METHODOLOGY:-
The research methodology is based on primary and primary and secondary sources .The information thus collected by market surveys through the medium of questionnaires direct personal contact with various clients , the primary sources of collecting data were by way of questionnaires and interviews .The questionnaires basically contained the profile of clients , his understanding towards the concept of project apart from this it shows consumer’s interest towards entering into such type of contracts. The secondary sources of collecting data were from published report, books and various websites.
1.5 LIMITATIONS OF THE STUDY:-
Time factor was one of the greatest constraints in the study. Busy schedule and irritating attitude of the interviewees was another thing. As area of study was limited for me so it’s difficult to draw the conclusion.
But why are derivatives such a big hit in Indian market?
The derivatives products – index futures, index options, stock futures and stock options
provide a carry forward facility for investors to take a position (bullish or bearish) on an
index or a particular stock for a period ranging from one to three months.
The current daily settlement in the cash market has left no room for speculation. The
cash market has turned into a day market, leading to increasing attention to derivatives.
Unlike the cash market of full payment or delivery, you don’t need many funds to buy
derivatives products. By paying a small margin, one can take a position in stocks or
market index.
They provide a substitute for the infamous BADLA system.
The derivatives volume is also picking up in anticipation of reduction of contract size from the
current Rs.200, 000 to Rs.100, 000.
Everything works in a rising market. Unquestionably, there is also a lot of trading interest in
the derivatives market.
CHAPTER- 2 2.1 Company profile
Reliance money is a part of Reliance Capital Limited, One of India’s Leading & fastest growing private sector financial services companies, Ranks Among the top 3 private sector financial services companies, in terms of net worth, With interests in Asset Management and Mutual Funds, Life and General Insurance, Credit Cards and other activities in financial services.
Reliance Money offers a single window platform for the financial transactions. Offering an investment avenue for a wide range of asset classes like Equity, Equity & Commodity Derivatives, Mutual Funds, IPO’s Life and General Insurance, Offshore Investments, Money Transfer, Money Changing and Credit Card. Their endeavor is to change the way India transacts in financial markets and avails financial services. One of their key features is that the most cost-effective, convenient and secure way to transact in a wide range of financial products and services. Reliance Money is targeting the low level of retail penetration in Indian retail financial market. Retail participation in equities in India is amongst the lowest in the world, with less than 5 per cent of household sector financial savings invested in equity/equity-related assets.
The company has formally commenced operations in April 2007.
Highlights of Reliance Money
Cost- effective : The fee charged by the affiliates of Reliance Money, through Whom the transactions can be placed, is among the lowest charged in the Present scenario & would revolutionize the broking fee structure
Convenience: You have the flexibility to access Reliance Money Services in Multiple ways: through the Internet, Transaction Kiosks, Call & Transact (phone) or seek assistance through our Business Partners.
Security : Reliance Money provides secure access through an electronic Token that flashes a unique security number every 32 seconds (and ensures that the Number used for the earlier transaction is discarded). The number Works as a third level password that keeps your account extra safe.
Single window for multiple products : Reliance Money, through its affiliates/partners, facility in equity & commodity derivative offshore investments, mutual funds, IPO’s, life insurance and general insurance products.
3 in 1 integrated access : Reliance Money offers integrated access to your banking, trading and de-mat account. And transact without the hassle of writing cheques.
VISION STATEMENT OF RELIANCE MONEY
“To be world leader in the business by providing a convenient transparent and Trustworthy online platform for effective wealth management”
MISSION STATEMENT
“To offer unparallel value by providing the customer transparent, convenient and Effective anytime-anywhere integrated financial transaction capability”
2.1.1 Origin and development of the industry
The Parent Company “ Reliance Capital Ltd”
COMPANY OVERVIEW
Reliance Capital Limited (RCL) is a depository participant with National Securities Depository Ltd (NSDL) and Central Depository Services Ltd (CDSL) under the Securities and Exchange Board of India (Depositories and Participants) Regulations; 1996.The Company primarily focuses on funding projects in the Infrastructure sector and supports the growth of its subsidiary companies.
The company primarily operates in India. It is headquartered in Navi Mumbai, India and employs about 140 people. The company recorded revenues of INR6, 520 million (approximately $146.6 million) during the fiscal year ended March 2006. As compared to revenues of INR 2,956.9millions during 2005. The Operating profit of the company was INR5, 506.1 million (approximately $123.8million) during fiscal year 2006, as compared to an operating profit of INR 1112.1millions during 2005. The net profit was INR5, 376, 1 million (approximately $120.9 million) in fiscal year 2006, as compared to a net profit of INR1, 058.1 million during 2005.
2.1.2 BUSINESS DESCRIPTION
Reliance Capital (RCL), a member of the Reliance Group, is a private sector financial services company. Reliance Capital is engaged in asset management and mutual funds, life and general insurance, private equity and proprietary investments, stock broking and other financial services. RCL primarily focuses on funding projects in the infrastructure sector and supports the growth of its subsidiary companies, Reliance Capital Asset Management, Reliance Capital Trustee; Reliance General Insurance of Reliance Life Insurance, Reliance Capital Asset Management, and a wholly owned subsidiary of Reliance Capital manages Reliance Mutual Fund schemes. Reliance Mutual Fund and Reliance money offers investors a well-rounded portfolio of products to meet varying investor requirements. Reliance Mutual fund is active in over 80 cities across India with an investor base of over 2 million and manages assets over Rs 27,914 crore as on May 31, 2006.
Reliance Life Insurances is an associate company of RCL offering a range of products catering for individual and corporate clients. The company has a total of 16 products in its range, covering savings, protection and investment requirements. Reliance General Insurance, a Subsidiary of RCL, is a non-life insurance company offering a range of insurance products covering risks including property, marine, casualty and liability.
VISION OF THE COMPANY
“To aspire to the highest global standards of quality and efficiency, operational performance, and customer care and to be the world leader in the Business world-class financial services enterprise”
2.1.3 MISSION
To attain global best practices and become a world-class financial Services enterprise –
guided by its purpose to move towards greater degree of sophistication and maturity.
To work with vigor, dedication and innovation to achieve excellence in service, quality,
reliability, safety and customer care as the ultimate goal...
To earn the trust and confidence of all stakeholders, exceeding their expectations and make
the Company a respected household name.
To consistently achieve high growth with the highest levels of productivity.
To be a technology driven, efficient and financially sound organization.
To contribute towards community development and nation building.
To be a responsible corporate citizen nurturing human values and concern for society, the
environment and above all, people.
KEY EMPLOYEES
Name Job Title Board
Anil Dhirubhai Ambani Chairman Executive Board
Shri Amitabh Jhunjhunwala Vice Chairman No Executive Board
Rajendra Chitale Director No Executive Board
C P Jain Director No Executive Board
Udyan Bose Director No Executive Board
V R Mohan Company secretary and
manager
Senior Management
2.2 CHAIRMAN’S PROFILE
Regarded as one of the foremost corporate leaders of contemporary India,
Shri. Anil D Ambani, 48, is the chairman of all listed companies of the Reliance ADA Group, namely, Reliance Communications, Reliance Capital, Reliance Energy and Reliance Natural Resources limited.
He is credited with having pioneered a number of path-breaking financial innovations in the Indian capital markets. He spearheaded the country’s first forays into the overseas capital markets with international public offerings of global depositary receipts, convertibles and bonds. Starting in 1991, he directed Reliance Industries in its efforts to rise over US$ 2 billion. He also steered the 100-year Yankee bond issue for the company in January 1997.
2.2.1 MAJOR PRODUCTS AND SERVICES
Reliance Capital is a non-banking finance company. Its services include:
Asset management Mutual funds Life insurance General insurance Offshore investments. Proprietary investments Stock broking
2.2.3 PRODUCTS OF RELIANCE MONEY:
1. EQUITY
Introduction-
Investing in equity, which offers returns that are higher than the inflation rate, helps you build wealth and improve your standard of living. The risk involved with investing in equity can be moderated by careful stock selection and close monitoring.
He is also Chairman of the Board of Governors of Dhirubhai Ambani Institute of Information and Communication Technology, Gandhi Nagar, Gujarat. Till recently, he also held the post of Vice Chairman and Managing Director in Reliance Industries Limited (RIL), India’s largest private sector enterprise. Anil D Ambani joined Reliance in 1983 as Co-Chief Executive Officer, and was centrally involved in every aspect of the company’s management over the next 22 years.
What is equity?
Acquiring equity shares of a company signifies ownership in that company to the extent of shares that you have acquired.
Returns from equity
By investing in equity, you earn returns in two ways-
Capital Appreciation: Over the longer term, with growth of a company’s business, its share price increases in value. This, in turn, increases the value of your holding in this company.
Dividend Income: The profits made by a company in a given financial year are sometimes partly distributed to its shareholders. This pay out is termed as dividend. The quantum of dividend that you are entitled to, will depend on the number of shares that you hold.
Investing process in equity There are two kinds of companies- one, whose shares are listed and traded on the stock exchange and another, whose shares are privately held by the promoters and their friends and associates. You can buy shares of the listed company from the stock exchange (through a broker) or you can apply for the shares of the privately held company when it decides to offer its shares to the public through its Initial Public Offering (IPO). Buying stocks from the stock exchange is termed as buying from the ‘secondary market’ and making an application for allotment of shares in a company’s IPO is called buying in the ‘primary market’.
DEMAT ACCOUNT AND INDIA
There are quite a few institutions that are directly and/or indirectly connected with dematerialized operations of securities. Understanding the Inter-linkages and functional responsibilities of these institutions will help us to have correct and holistic perspective above functioning of dematerialization.
The institutions connected with Demat operations include;
a)Depositories,
b) Stock Exchanges (SEs),
c) Clearing Corporations (CCs) or Clearing Houses (CHs),
Trading activates are not free. They have a considerably high level of risk, Uncertainty and complexity, especially for unwise and inexperienced stock Traders/investors seeking for an easy way to make money quickly. In addition, stock traders/investors face several costs such as commissions, Taxes and fees to be paid for the brokerage and other services, like the buying/selling orders placed at the stock exchange. According to each National or State legislation, a large array of fiscal obligations must be respected, and taxes are charged by the State over the transactions and Earning. Beyond these costs, the opportunity costs of money and time, the currency risk, the financial risk, and all the Internet Service Provider, data and News agency services and electricity consumption must be added.
2. COMMODITIES
Commodities have occupied a large space in our life without us ever noticing them. We have always brought commodities either for our survival or to make our life comfortable. But now, we can trade in commodities. It’s just like buying and selling shares of company, here we buy and sell commodities. And it can be done without owning an iota of the commodity you trade in.
The commodities being traded are
1. Agriculture – based commodities such as rice, wheat, sugar, etc.
2. Mineral – based commodities such as gold, platinum, aluminum, copper, zinc, etc.
3. Energy – crude oil etc.
1. Commodity exchanges Commodities are traded on different exchanges throughout the world. In India, three of the most prominent commodity exchanges are
1. The Multi Commodity Exchange of India [MCE].2. The National Commodity and Derivative Exchange [NCDEX].3. The National Multi Commodity Exchange of India [MNCE]. All three exchanges are national exchanges where trading can be undertaken from any part of the country.
How commodity trading takes places:
1. Main commodities permitted and traded on the exchanges. Gold, silver, guar gum, chana, jeera, chilly, menthe oil, crude oil, steel, Soya oil and sugar.
Trading timings
Monday to Friday: 10 am – 5 pm for agro based commodities. Monday to Friday : 10 am – 11.30 pm for precious/base metals and energy Saturday: 10 am – 2 pm for all commodities.
2. Spot trading in commodities
In spot markets for commodities, trading, clearing and settlement is carried out on spot. Spot trading is almost carried out in regional mandis and unorganized markets. These markets are fragmented and isolated. There are over 7000 mandis in India, trading in 140 crops. The traders in mandis are farmers, licensed traders, brokers and wholesale dealers. Mandis inspectors issue type and quantity certificates. Mandi fees include transaction fee and taxes varies from 4% to 12%.
MUTUAL FUNDS
Worldwide, the mutual fund or unit trust as it is called in some parts of the world, has a long and successful history. In developed financial markets, like the United States, mutual funds have almost overtaken bank deposits and total assets of insurance funds. In India the mutual fund industry started with setting up of unit trust of India in 1964. Public sector banks and financial institutions began to establish mutual funds in 1987. The private sector and foreign institutions were allowed to setup mutual fund in 1993. Today, there are 36 mutual funds and over 200 schemes with total assets of approximately Rs. 81000 Crores. This fast growing industry is regulated by Securities and Exchange Board of India. (SEBI).
Reliance Mutual Fund (RMF)
Reliance Mutual Fund (RMF), a part of the Reliance - Anil Dhirubhai Ambani Group, is India's leading Mutual Fund, with Assets Under Management of Rs. 77,765 Crores (AUM as on 30th November 2007), and an investor base of over 4.2 million. Reliance Mutual Fund is one of the fastest growing mutual funds in the country. Reliance Mutual Fund offers investors a well rounded portfolio of products to meet varying investor requirements. Reliance Mutual Fund has a presence in 300 cities across the country and constantly endeavors to launch innovative products and customer service initiatives to increase value to investors. Reliance Mutual Fund schemes are managed by Reliance Capital Asset Management Ltd., a wholly owned subsidiary of Reliance Capital Ltd
IPO [INITIAL PUBLIC OFFER]
IPO’s which means initial public offer which is the offering of shares or others to the public. The public can subscribe shares offered by the company. A company that is planning an IPO appoints lead managers (SEBI-registered merchant bankers who are responsible for helping the company execute the IPO) to help it decide on an appropriate price at which the shares should be issued. There are two ways in which the price of an IPO can be determined – either the company, with the help of its lead managers, fixes a price or the price is arrived at through the process of book building.
There are two ways in which the price of an IPO can be determined:
Fixed IPO’s
In this case, the company, together with the lead managers, decides at what price they would like to issue the shares. To arrive at a suitable price, the company’s past performance is assessed using financial ratios. The share prices of competitor companies’ equities and others in the same league are also taken into consideration when the IPO price is fixed.
Book-built IPO’s
In the book building approach to price setting, the price of an IPO is demand driven. The issuing company sets a floor or base price and a band within which an investor is allowed to bid for shares. The spread between the floor and the cap of the price band cannot be more than 20 per cent of the floor price. Then the company, through its lead managers, invites price bids from investors along with the quantum of securities that they would be willing to purchase at that price.
3. INSURANCE
Reliance Life Insurance Reliance Life Insurance, a part of the Reliance - Anil Dhirubhai Ambani Group is India’s fastest growing life insurance company and among the top 5 private sector life insurers. Reliance Life Insurance has a pan India presence and a range of products catering to individual as well as corporate needs. Reliance Life Insurance has over 700 branches and 1, 50,000 agents. It offers 23 products covering savings, protection & investment requirements. Reliance Life Insurance will endeavor to attain a leadership position in the market over the next few years, by further expanding and strengthening its distribution network and offering a diverse array of products to suit the varied and specific needs of individual customers.
Reliance General Insurance
Reliance General Insurance, a part of the Reliance - Anil Dhirubhai Ambani Group and a Subsidiary of Reliance Capital, is one of the first non-life companies to get the license from the IRDA. Reliance General Insurance is India’s fastest growing general insurance company and the top 3 private sector insurers. Reliance General Insurance has 200 branches across 171 cities and over 25,000 intermediaries. Reliance General Insurance offers an exhaustive range of insurance products that covers most risks including Auto, Health, Property, Marine, Casualty and Liability.
4. FOREIGN EXCHANGE
Introduction to Forex
Forex, or Foreign Exchange, is the simultaneous exchange of one country's currency for that of another. Traders in the FOREX market wish to purchase or sell one currency for another with the hope of making a profit when the value of the currencies changes in favor of the investor, whether from market news or events that takes place in the world. The foreign exchange (FX or FOREX) market is the market where exchange rates are determined. Exchange rates are the mechanisms by which world currencies are tied together in the global marketplace, providing the price of one currency in terms of another.
The Forex Market
The foreign exchange market is the generic term for the worldwide institutions that exist to exchange or trade the currencies of different countries. It is loosely organized in two tiers: 1) The retail tier and 2) The wholesale tier.
5. GOLD
Gold has always been an important element of Indian tradition. Even today, it is an important financial investment. India is the largest consumer of gold in the world and we feel that it is important to add this to our portfolio of existing products and services. India is a biggest market for gold. The country imports over 800 tonnes of gold a year. Jaipur, May 3 (IANS) Reliance Money, part of the Anil Dhirubhai Ambani Group, Thursday announced its foray into retailing of gold coin after it tied up with Swiss precious metal refining major Valcambi. With this, the company will sell 24 carat 999.9 pure gold coins in denominations of 5gm and 8gm at its select Reliance Money and Reliance World outlets of Reliance Communications. The launch comes within a month of Reliance Money’s foray into distribution of a range of financial products and services in the country.
PRESENT STATUS OF THE ORGANIZATION
Reliance Capital for the last financial year made a profit of over Rs1000crs. Today the Group has some 37,000 employees both full time and on contract. The businesses Reliance Capital has focused on has been are as follows:
Consumer Finance –
Like Reliance Money, In it’s first year of Operations, Consumer Finance has become the third largest consumer finance portfolio in the country with a book size of approximately Rs.7000Crores Other businesses - include investments and proprietary trading The company has begun this financial year with an agenda to accelerate growth in all the businesses mentioned above and also started some new business initiatives as described below.
Asset Reconstruction–
We have received all necessary regulatory clearances and hope to kick start operations at the earliest.
In-house Distribution Company - to distribute Reliance financial services products to its employees; customers and shareholders
Institutional Broking – to serve the Trading needs of Corporate & Financial Institutions.
Future growth drivers
The future growth of the company will be propelled by the quality of human capital, the use of cutting-edge technology, and our extensive distribution reach. Technology, together with human and intellectual capital, will be the key differentiators for the company going forward. The company shall use those strategic tools to reduce the cost of delivery, improve the speed of execution and enhance customer experience at every point of interface.
2.2.4 RELIANCE MONEY Power trade:
This is the terminal which the RELIANCE MONEY and known as POWERTRADE. Only RELIANCE MONEY has license to use this software. In this franchisee linked customers account will be held by the business associates. This makes the clients to make their trading mechanism easy. And the service provider charges Rs 15/- per trade on flat, i.e. the trader doesn’t have any restriction on his trading amount. Even the service provider gets the notes on latest trend in market and also the movement of the markets by the RELIANCE news team, popularly known as REUTERS. This team is only linked with RELIANCE MONEY.
2.3 SWOT ANALYSIS
A type of fundamental analysis of the health of a company by examining its strengths(S), weakness (W), business opportunity (O), and any threat (T) or dangers it might be exposed to.
I. STRENGTHS
Brand strategy : as opposed to some of its competitors (e.g. HSBC), Reliance ADAG operates a multi-brand strategy. The company operates under numerous well-known brand names, which allows the company to appeal to many different segments of the market.
Distribution channel strategy : Reliance is continuously improving the distribution of its products. Its online and Internet-based access offers a combination of excellent growth prospects and its retail direct business also saw growth of 27% in 2002 and 15% in 2003.
Various sources of income : Reliance has many sources of income throughout the group, and this diversity within the group makes the company more flexible and resistant to economic and environmental changes.
Large pool of installed capacities.
Experienced managers for large number of Generics.
Large pool of skilled and knowledgeable manpower.
Increasing liberalization of government policies.
II. WEAKNESS
Emerging markets : since there is more investment demand in the United States, Japan and the rest of Asia, Reliance should concentrate on these markets, especially in view of low global interest rates. Mutual funds are like many other investments without a guaranteed return: there is always the possibility that the value of your mutual fund will depreciate.
Unlike fixed income products, such as bonds and Treasury bills, mutual funds experience price fluctuations along with the stocks that make up the fund. When deciding on a particular fund to buy, you need to research the risks involved – just because a professional manager is looking after the fund, that doesn’t mean the performance will be stellar.
Fees: In mutual funds, the fees are classified into two categories: shareholder fees and annual operating fees. The shareholder fees, in the forms of loads and redemption fees are paid directly by shareholders purchasing or selling the funds. The annual fund operating fees are charged as an annual percentage – usually ranging from 1-3%. These fees are assessed to mutual fund investors regardless of the performance of the fund. As you can imagine, in years when the fund doesn’t make money, these fees only magnify losses.
III. OPPORTUNITIES
Potential markets : The Indian rural market has great potential. All the major market leaders consider the segments and real markets for their products. A senior official in a one of the leading company says foray into rural India already started and there has been realization that the rural market is both price and quantity conscious.
Entry of MNCs : Due to multinationals are entering into market job opportunities are increasing day by day. Also India Mutual Fund majors are tie up with other financial institutions.
IV. THREATS
Increased Competition : With intense competition by so many local players causing headache to the current marketers. In addition to this though multinational brands are not yet established but still they will soon hit the mark. Almost 60 to 70% of the revenue is spending on the management and services. Hedge funds : sometimes referred to as hot money, are also causing a threat for mutual funds have gained worldwide notoriety for bringing the markets down. Be it a crash in the currency, A stock or A bond market, A usually a hedge fund prominently figures somewhere in the picture
CHAPTER - 3
3.1 INTRODUCTION TO DERIVATIVES:
Today, derivatives have become most important part of the day-to-day life for ordinary people in most parts of the world. The Oxford dictionary defines a derivative as something derived or obtained from another, coming from a source; not original. In the field of financial economics, a derivative security is generally referred to a financial contract whose value is derived from the value of an underlying asset or simply underlying. There are a wide range of financial assets that have been used as underlying, including equities or equity index, fixed-income instruments, foreign currencies, commodities, credit events and even other derivative securities. Depending on the types of underlying, the values of the derivative contracts can be derived from the corresponding equity prices, interest rates, exchange rates, commodity prices and the probabilities of certain credit events.
3.2 Basics of Derivative:-
Derivative is a contract or a product whose value is derived from value of some other asset known as underlying. Derivatives are based on wide range of underlying assets. These include:
• Metals such as Gold, Silver, Aluminium, Copper, Zinc, Nickel, Tin, Lead.
• Energy resources such as Oil and Gas, Coal, Electricity.
• Agri commodities such as wheat, Sugar, Coffee, Cotton, Pulses and
• Financial assets such as Shares, Bonds and Foreign Exchange.
3.3 Derivatives Market – History & Evolution:-
History of Derivatives may be mapped back to the several centuries. Some of the specific milestones in evolution of Derivatives Market Worldwide are given below:
12th Century- In European trade fairs, sellers signed contracts promising future delivery of the items they sold.
13th Century- There are many examples of contracts entered into by English Cistercian Monasteries, who frequently sold their wool up to 20 years in advance, to foreign merchants.
In 1972, Chicago Mercantile Exchange created International Monetary Market, which allowed trading in currency futures.
In 1975, CBOT introduced Treasury bill futures contract. It was the first successful pure interest rate futures.
In 1977, CBOT created T -bond futures contract.
In 1982, CME created Eurodollar futures contract.
In 1982, Kansas City Board of Trade launce.
Derivatives markets:
Derivatives are traded either on organised exchanges or in OTC markets. The differences between the exchange-traded and OTC derivatives are not confined to where they are traded but also how. In exchange-traded markets, derivatives contracts are standardised with specific delivery or settlement terms. Negotiation between traders traditionally was conducted by shouting on the trading floor (open outcry). But electronic trading system has become increasingly popular in many major exchanges.
Exchange-traded derivative trades are publicly reported and cleared in a clearing house. The clearing house will be obliged to honour the trade if the seller defaults. The solvency of the clearing house was protected by marking all positions to market daily through a system of margins. By contrast, derivative trades in OTC markets are bilateral in nature. All contract terms such as delivery quality, quantity, location, date and prices are negotiable between the two parties. Transactions can be arranged by telephone or other communication means.
Exchange traded derivative markets have better price transparency than OTC markets. Counterparty risks are also smaller in exchange-traded markets with all trades on
exchanges being settled daily with the clearing house. On the other hand, the flexibility of OTC market means that they suit better for trades that do not have high order flow and or with special requirements. In this context, OTC market performs the role as an incubator for new financial products.
3.4 Products in Derivatives Market
Forwards
It is a contractual agreement between two parties to buy/sell an underlying asset at a certain future date for a particular price that is pre-decided on the date of contract. Both the contracting parties are committed and are obliged to honour the transaction irrespective of price of the underlying asset at the time of delivery. Since forwards are Negotiated between two parties, the terms and conditions of contracts are customized. These are OTC contracts.
Futures
A futures contract is similar to a forward, except that the deal is made through an organized and regulated exchange rather than being negotiated directly between two parties. Indeed, we may say futures are exchange traded forward contracts.
Options
An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying on or before a stated date and at a stated price. While buyer of option pays the premium and buys the right, writer/seller of option receives the premium with obligation to sell/ buy the underlying asset, if the buyer exercises his right.
Swaps
A swap is an agreement made between two parties to exchange cash flows in the future according to a prearranged formula. Swaps are series of forward contracts. Swaps help market participants manage risk associated with volatile interest rates, currency exchange rates and commodity prices.
3.5 Market Participants
There are broadly three types of participants in the derivatives market - hedgers, traders (also called speculators) and arbitrageurs. An individual may play different roles in different market circumstances.
Hedgers:-
They face risk associated with the prices of underlying assets and use derivatives to reduce their risk. Corporations, investing institutions and banks all use derivative products to hedge or reduce their exposures to market variables such as interest rates, share values, bond prices, currency exchange rates and commodity prices.
Speculators :-
They try to predict the future movements in prices of underlying assets and based on the view, take positions in derivative contracts. Derivatives are preferred over underlying asset for speculation purpose, as they offer leverage, are less expensive (cost of transaction is generally lower than that of the underlying) and are faster to execute in size (high volumes market).
Arbitrageurs
Arbitrage is a deal that produces profit by exploiting a price difference in a product in two different markets. Arbitrage originates when a trader purchases an asset cheaply in one location and simultaneously arranges to sell it at a higher price in another location. Such opportunities are unlikely to persist for very long, since arbitrageurs would rush in to these transactions, thus closing the price gap at different locations.
3.6 Risk Faced By the Investor :-
Obviously investment in derivative involves risk as it is more volatile and provides more returns with a less investment than other investment mediums. But it is the duty of the investor to assess the risk factor and trade coolly.
Types of risks faced:-
Risks are divided into few elementary forms such as
Operational risk: - the risk of loss arising due to procedure errors omissions or
failures of internal control systems.
Market risk: - the risk of loss arising out of adverse market rate movements. E.g.,
foreign exchange.
Interest rate Risk: - the change in capital values of an investment resulting from
changes in prevailing interest rate levels.
Credit risk:- the risk of losses arising from defaults by the counterparty
Liquidity risk: - the risk of losses arising from a derivative market becoming
liquid.
Business risk: - the risk that one transaction or a small group of transactions causing
losses, exposes the firm to risk of failure.
Political risk: - this includes tax, trade, regulation, education and social policies.
During the present period, banks have increased their exposure to OTC derivative instruments at
such a faster rate that supervisory authorities the world over are getting worried about the risks
such exposures involve for the banks. The explosive growth in derivatives has been the result
both of intense competition amongst major international banks (as the role have been changed to
profitability) and the need of the corporate world, indeed the whole “real” economy, to hedge
exposures in volatile markets. As the increase of players entering market which decrease the
margins. Derivatives provide their important economic functions:
(1) Risk management
(2) Price discovery; and
(3) Transactional efficiency
This should be the following measure to reduce disasters with derivatives: -
At the level of exchanges, position limits and surveillance procedures should be sound.
At the level of clearing houses, margin requirements should be stringently enforced, even
when dealing is with large institutions.
At the level of individual companies with positions in the market, modern risk measurement
systems should be established alongside the creation of capabilities in
3.7 MANAGEMENT OF RISK
The risk management and control of risk requires an in-depth knowledge of risks, how they are identified, hoe they are measured and where possible, how they are controlled, this requires both deep understanding of how the business is actually conducted and how critical areas within the business process can be measured.
Why an investor manages risk?
An investor needs to manage risks in order to overcome various factors. Which are as follows?
Changes in accounting practices. Regulatory initiatives. Market events. Optimisation of capital. Increase in complexity of financial markets.
Technology advances.
CHAPTER-4
INDEX
INTRODUCTION TO INDEX
Index is a statistical indicator that measures changes in the economy in general or in particular areas. In case of financial markets, an index is a portfolio of securities that represent a particular market or a portion of a market. Each Index has its own calculation methodology and usually is expressed in terms of a change from a base value. The base value might be as recent as the previous day or many years in the past. Thus, the percentage change is more important than the actual numeric value. Financial indices are created to measure price movement of stocks, bonds, T-bills and other type of financial securities.
Significance of Index
• A stock index is an indicator of the performance of overall market or a particular sector.
• It serves as a benchmark for portfolio performance - Managed portfolios, belonging either to individuals or mutual funds; use the stock index as a measure for evaluation of their performance.
• It is used as an underlying for financial application of derivatives – Various products in OTC and exchange traded markets are based on indices as underlying asset.
Popular indices in India
Sensex and Nifty were earlier designed on market capitalization weighted method. Indeed, both Sensex and Nifty, over a period of time, have moved to free float basis.
Price-Weighted Index
A stock index in which each stock influences the index in proportion to its price. Stocks with a higher price will be given more weight and therefore, will have a greater influence over the performance of the index. Dow Jones Industrial Average and Nikkei 225 are popular
price-weighted indices.
Equal Weighted Index
An equally-weighted index makes no distinction between large and small companies, both of which are given equal weighting. The value of the index is generated by adding the prices of each stock in the index and dividing that by the total number of stocks.
Major Indices in India
These are few popular indices in India.
• BSE Sensex • BSE Midcap
• BSE-100 • BSE-200
• BSE-500 • S&P CNX Nifty
• CNX Nifty Junior • S&P CNX Defty
• CNX Midcap • S&P CNX 500
A View Of Live Indices:
CHAPTER-5 FUTURES & FORWARDSIntroduction to forwards
Forward contract is an agreement made directly between two parties to buy or sell an asset on a specific date in the future, at the terms decided today. Forwards are widely used in commodities, foreign exchange, equity and interest rate markets. Unlike future contracts they are not traded in an exchange rather in the Over The Counter (OTCs) market usually between a
financial institution and between a financial & one of its clients.
Features:-
Forward are bilateral contracts & hence are exposed to counter party risk. This is the risk of non payment of obligation by either party.
Each contract is custom designed & hence is unique in terms of contract size, expiration date, asset type & quality.
In forward contracts one of the parties takes long position by agreeing to buy the asset at a certain specified future date .The other party assumes a short position by agreeing to sell the same asset at the same date for a same specified price.
INTRODUCTION TO FUTURES
A future is a contract to buy or sell an asset at a specified future date at a specified price. These contracts are traded in stock exchanges and it can change many hands before settlement.
The advantage in future contracts is that it eliminates counterparty risk due to exchange guarantees in trade.
MARGIN
Margin is the deposit money that needs to be paid to buy or sell each contract Margin Account As exchange guarantees the settlement of all the trades, to protect itself against default by either counterparty, it charges various margins from brokers. Brokers in turn charge margins from their customers.
Generally there are four types of margins in future contracts. They are as follows.
1) Initial margin
This amount is deposited at the time entering into the contract. This margin is meant to cover the largest potential loss in one day
2) Maintenance margin :- A trader is entitled to withdraw any balance in the margin account in excess of the initial margin. To ensure that the balance in the margin account never becomes negative.
3)Additional margin: Marking to Market (MTM)
In futures market, while contracts have maturity of several months, profits and losses are settled on day-to-day basis – called mark to market (MTM) settlement. The exchange collects these margins (MTM margins) from the loss making participants and pays to the gainers on day-to-day.
FUTURE PAYOFFs
Generally future contracts have linear or symmetrical payoffs. It means that the profits as well as losses for both the buyers and sellers are unlimited. And this can be generating various complex payoffs when it combines with options.
Payoff for buyer of futures: Long futures
Recall that the buyer of a futures contract agrees to purchase a certain quantity of a particular commodity or financial instrument at a pre-specified price and time. The seller of the futures contract promises to deliver the commodity or financial instrument on the appointed date in return for payment at the settlement price. The value of these promises (to the buyer) increases as the price of the underlying asset rises.
Figure shows the payoff from buying a futures contract. As the price of the underlying asset rises above the settlement price, the payoff to the futures contract buyer goes up one for one – that is to say, a $1 dollar increase in the price of the underlying asset raises the payoff to the long position by $1. As the price falls below the settlement price, the value of the long position falls. In fact, the payoff from purchasing the underlying asset itself is exactly the same as the payoff from buying a future, since arbitrage forces the futures price to move with the price of the underlying asset. The crucial difference is that, in buying a futures contract, all the buyer needs
to do is post margin. While buying a futures contract is substantially cheaper than buying the underlying asset, it means accepting greater risk.
PAYOFF FOR SELLER OF FUTURES: SHORT FUTURES
The payoff for a person who is having short the futures contract is similar to who shorts an asset. He has unlimited upside risk as well as downside .
Suppose , A speculator who sells a two month nifty index futures contract when nifty stands at 4000. So, his reward starts when index moves down, when the index moves up, it starts making losses.
Pay off graph for a seller of nifty futures:
The payoff from selling a futures contract, or taking the short position, is shown in Figure This mirror image of Figure 9A.1 shows that the buyer’s gains are the seller’s losses, and vice versa. Again, the payoff to the short position rises and falls one-for-one with theprice of the underlying asset – a $1 increase in the price of the underlying asset reduces the payoff to the seller by $1, while a $1 fall in the price raises the payoff by $1.
CHAPTER-6
OPTIONS
1. INTRODUCTION TO OPTIONS
An option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, at a particular price (Strike price / Exercise price) in future. In return for granting the option, the seller collects a payment (the premium) from the buyer. Exchange traded options form an important class of options which have standardized contract features and trade on public exchanges, facilitating trading among large number of 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, for arbitrage or for implementing strategies which can help in generating income for investors under various market conditions.
1.1 OPTION TERMINOLOGY
Index options: These options have the index as the underlying. In India, they havea European style settlement. Eg. Nifty options, Mini Nifty options etc.
Stock options: Stock options are options on individual stocks. A stock option contract gives the holder the right to buy or sell the underlying shares at the specified price. They have an American style settlement.
Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.
Writer / seller of an option: The writer / seller of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.
Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.
Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price.
Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.
Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity.
Strike price: The price specified in the options contract is known as the strike price or the exercise price.
American options: American options are options that can be exercised at any time upto the expiration date.
European options: European options are options that can be exercised only on the expiration date itself.
In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cashflow to the holder if it were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price.
At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cashflow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price).
Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cashflow if it were exercised immediately. A call option on the index is out-of-the-money when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price.
Intrinsic value of an option: The option premium can be broken down into two components - intrinsic value and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero.
Time value of an option: The time value of an option is the difference between its premium and its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an option's time value, all else equal. At expiration, an option should have no time value.
OPTIONS PAYOFFS
The optionality characteristic of options results in a non-linear payoff for options. In simple words, it means that the losses for the buyer of an option are limited, however the profits are potentially unlimited. For a writer (seller), the payoff is exactly the opposite. His profits are limited to the option premium, however his losses are potentially unlimited. These nonlinear payoffs are fascinating as they lend themselves to be used to generate various payoffs by using combinations of options and the underlying. We look here at the six basic payoffs (pay close attention to these pay-offs, since all the strategies in the book are derived out of these basic payoffs).
Payoff profile of buyer of asset: Long asset
In this basic position, an investor buys the underlying asset, ABC Ltd. shares for instance, for Rs. 2220, and sells it at a future date at an unknown price, St. Once it is purchased, the investor is said to be "long" the asset. Figure 1.1 shows the payoff for a long position on ABC Ltd.
Payoff profile for seller of asset: Short asset
In this basic position, an investor shorts the underlying asset, ABC Ltd. shares for instance, for Rs. 2220, and buys it back at a future date at an unknown price, St. Once it is sold, the investor is said to be "short" the asset. Figure 1.2 shows the payoff for a short position on ABC Ltd.
The figure shows the profits/losses from a short position on ABC Ltd.. The investor sold ABC Ltd. at Rs. 2220. If the share price falls, he profits. If the share price rises, he loses.
Payoff profile for buyer of call options: Long call
A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. If upon expiration, the spot price exceeds the strike price, he makes a profit. Higher the spot price, more is the profit he makes. If the spot price of the underlying is less than the strike price, he lets his option expire un-exercised. His loss in this case is the premium he paid for buying the option. Figure 1.3 gives the payoff for the buyer of a three month call option (often referred to as long call) with a strike of 2250 bought at a premium of 86.60.
The figure shows the profits/losses for the buyer of a three-month Nifty 2250 call option. As can be seen, as the spot Nifty rises, the call option is in-the-money. If upon expiration, Nifty closes above the strike of 2250, the buyer would exercise his option and profit to the extent of the difference between the Nifty-close and the strike price. The profits possible on this option are potentially unlimited. However if Nifty falls below the strike of 2250, he lets the option expire. His losses are limited to the extent of the premium he paid for buying the option.
Payoff profile for writer (seller) of call options: Short call
A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. For selling the option, the writer of the option charges a premium. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. Whatever is the buyer's profit is the seller's loss. If upon expiration, the spot price exceeds the strike price, the buyer will exercise the option on the writer. Hence as the spot price increases the writer of the option starts making losses. Higher the spot price, more is the loss he makes. If upon expiration the spot price of the underlying is less than the strike price, the buyer lets his option expire un-exercised and the writer gets to keep the premium. Figure 1.4 gives the payoff for the writer of a three month call option (often referred to as short call) with a strike of 2250 sold at a premium of 86.60.
The figure shows the profits/losses for the seller of a three-month Nifty 2250 call option. As the spot Nifty rises, the call option is in-the-money and the writer starts making losses. If upon expiration, Nifty closes above the strike of 2250, the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the Nifty-close and the strike price. The loss that can be incurred by the writer of the option is potentially unlimited, whereas the maximum profit is limited to the extent of the up-front option premium of Rs.86.60 charged by him.
Payoff profile for buyer of put options: Long put
A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. If upon expiration, the spot price is below the strike price, he makes a profit. Lower the spot price, more is the profit he makes. If the spot price of the underlying is higher than the strike price, he lets his option expire un-exercised. His loss in this case is the premium he paid for buying the option. Figure 1.5 gives the payoff for the buyer of a three month put option (often referred to as long put) with a strike of 2250 bought at a premium of 61.70.
The figure shows the profits/losses for the buyer of a three-month Nifty 2250 put option. As can be seen, as the spot Nifty falls, the put option is in-the-money. If upon expiration, Nifty closes below the strike of 2250, the buyer would exercise his option and profit to the extent of the
difference between the strike price and Nifty-close. The profits possible on this option can be as high as the strike price. However if Nifty rises above the strike of 2250, he lets the option expire. His losses are limited to the extent of the premium he paid for buying the option.
Payoff profile for writer (seller) of put options: Short put
A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. For selling the option, the writer of the option charges a premium. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. Whatever is the buyer's profit is the seller's loss. If upon expiration, the spot price happens to be below the strike price, the buyer will exercise the option on the writer.
The figure shows the profits/losses for the seller of a three-month Nifty 2250 put option. As the spot Nifty falls, the put option is in-the-money and the writer starts making losses. If upon expiration, Nifty closes below the strike of 2250, the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the strike price and Niftyclose. The loss that can be incurred by the writer of the option is a maximum extent of the strike price (Since the worst that can happen is that the asset price can fall to zero) whereas the maximum profit is limited to the extent of the up-front option premium of Rs.61.70 charged by him.
OPTION STRATEGIES
There are number of strategies are invented for option investors in order to hedge against risk. These strategies are known as option strategies. Which may be a single option or may be combination of more than one options . Out of those some important strategies are discussed are under
STRATEGIES
1. LONG CALL2. SHORT CALL3. SYNTHETIC LONG CALL4. LONG PUT 5. SHORT PUT6. COVERED CALL7. LONG COMBO8. PROTECTIVE CALL9. COVERED PUT10.LONG STRADDLE11.SHORT STRADDLE12.LONG STRANGLE13.SHORT STRANGLE14.COLLAR15.BULL CALL SPREAD STRATEGY16.BULL PUT SPREAD STRATEGY17.BEAR CALL SPREAD STRATEGY18.BEAR PUT SPREAD STRATEGY19.LONG CALL BUTTERFLY20.SHORT CALL BUTTERFLY21.LONG CALL CONDOR22.SHORT CALL CONDOR
STRATEGY 1 : LONG CALL
For aggressive investors who are very bullish about the prospects for a stock / index, buying calls can be an excellent way to capture the upside potential with limited downside risk.
ANALYSIS: This strategy limits the downside risk to the extent of premium paid by Mr. XYZ (Rs. 36.35). But the potential return is unlimited in case of rise in Nifty. A long call option is the simplest way to benefit if you believe that the market will make an upward move and is the most common choice among first time investors in Options. As the stock price / index rises the long Call moves into profit more and more quickly.
STRATEGY 2 : SHORT CALL
When you buy a Call you are hoping that the underlying stock / index would rise. When you expect the underlying stock / index to fall you do the opposite. When an
investor is very bearish about a stock / index and expects the prices to fall, he can sell Call options. This position offers limited profit potential and the possibility of large losses on big advances in underlying prices. Although easy to execute it is a risky strategy since the seller of the Call is exposed to unlimited risk.
ANALYSIS : This strategy is used when an investor is very aggressive and has a strong expectation of a price fall (and certainly not a price rise). This is a risky strategy since as the stock price / index rises, the short call loses money more and more quickly and losses can be significant if the stock price / index falls below the strike price. Since the investor does not own the underlying stock that he is shorting this strategy is also called Short Naked Call.
STRATEGY 3 : SYNTHETIC LONG CALL: BUY STOCK, BUY PUT
In this strategy, we purchase a stock since we feel bullish about it. But what if the price of the stock went down. You w ish you had some insurance against the price fall. So buy
a Put on the stock. This gives you the right to sell the stock at a certain price which is the strike price. The strike price can be the price at which you bought the stock (ATM strike price) or slightly below (OTM strike price).
In case the price of the stock rises you get the full benefit of the price rise. In case the price of the stock falls, exercise the Put Option (remember Put is a right to sell). You have capped your loss in this manner because the Put option stops your further losses. It is a strategy with a limited loss and (after subtracting the Put premium) unlimited profit (from the stock price rise) . The result of this strategy looks like a Call Option Buy strategy and therefore is called a Synthetic Call .
But the strategy is not Buy Call Option (Strategy 1). Here you have taken an exposure to an underlying stock with the aim of holding it and reaping the benefits of price rise, dividends, bonus rights etc. and at the same time insuring against an adverse price movement.
ANALYSIS : This is a low risk strategy. This is a strategy which limits the loss in case of
fall in market but the potential profit remains unlimited when the stock price rises. A
good strategy when you buy a stock for medium or long term, with the aim of
protecting any downside risk. The pay-off resembles a Call Option buy and is therefore
called as Synthetic Long Call.
STRATEGY 4 : LONG PUT
Buying a Put is the opposite of buying a Call. When you buy a Call you are bullish about
the stock / index. When an investor is bearish, he can buy a Put option. A Put Option
gives the buyer of the Put a right to sell the stock (to the Put seller) at a pre-specified
price and thereby limit his risk.
ANALYSIS: A bearish investor can profit from declining stock price by buying Puts. He limits his risk to the amount of premium paid but his profit potential remains unlimited. This is one of the widely used strategy when an investor is bearish
STRATEGY 5 : SHORT PUT
Selling a Put is opposite of buying a Put. An investor buys Put when he is bearish on a stock. An investor Sells Put when he is Bullish about the stock – expects the stock price to rise or stay sideways at the minimum. When you sell a Put, you earn a Premium (from the buyer of the Put). You have sold someone the right to sell you the stock at the strike price. If the stock price increases beyond the strike price, the short put position will make a profit for the seller by the amount of the premium, since the buyer will not exercise the Put option and the Put seller can retain the Premium (which is his maximum profit). But, if the stock price decreases below the strike price, by more than the amount of the premium, the Put seller will lose money. The potential loss being unlimited (until the stock price fall to zero).
ANALYSIS : Selling Puts can lead to regular income in a rising or range bound markets . But it should be done carefully since the potential losses can be significant in case the price of the stock / index falls. This strategy can be considered as an income generating strategy.
STRATEGY 6 : COVERED CALL
You own shares in a company which you feel may rise but not much in the near term (or at best stay sideways). You would still like to earn an income from the shares. The covered call is a strategy in which an investor Sells a Call option on a stock he owns (netting him a premium). The Call Option which is sold in usually an OTM Call. The Call would not get exercised unless the stock price increases above the strike price. Till then the investor in the stock (Call seller) can retain the Premium with him. This becomes his income from the stock. This strategy is usually adopted by a stock owner who is Neutral to moderately Bullish about the stock.
An investor buys a stock or owns a stock which he feel is good for medium to long term but is neutral or bearish for the near term. At the same time, the investor does not mind exiting the stock at a certain price (target price). The investor can sell a Call Option at the strike price at which he would be fine exiting the stock (OTM strike). By selling the Call Option the investor earns a Premium. Now the position of the investor is that of a Call Seller who owns the underlying stock. If the stock price stays at or below the strike price, the Call Buyer will not exercise the Call. The Premium is retained by the investor.
In case the stock price goes above the strike price, the Call buyer who has the right to buy the stock at the strike price will exercise the Call option. The Call seller (the investor) who has to sell the stock to the Call buyer, will sell the stock at the strike price. This was the price which the Call seller (the investor) was anyway interested in exiting the stock and now exits at that price. So besides the strike price which was the target price for selling the stock, the Call seller (investor) also earns the Premium which becomes an additional gain for him. This strategy is called as a Covered Call strategy because the Call sold is backed by a stock owned by the Call Seller (investor). The income increases as the stock rises, but gets capped after the stock reaches the strike price.
When to use: - this is often employed when an investor has a short-term neutral to moderately bullish view on the stock he holds.
Example:
Mr. Ambani bought x ltd for 3800 & simultaneously sell a call option at the strike price 4000 at 80.
Current market price: - 3800 Short call option strike price: - 4000 at premium of 80 Call option breakeven: - 4000+80=4080 Option breakeven: - stock price paid – premium received
=3800-80= 3720
Thus if the price won’t move the investor will earn a sure income. But if the stock price decreases the investor has unlimited loss.
STRATEGY 7 : LONG COMBO : SELL A PUT,BUY A CALL.
A Long Combo is a Bullish strategy. If an investor is expecting the price of a stock to move up he can do a Long Combo strategy. It involves selling an OTM (lower strike) Put and buying an OTM (higher strike) Call. This strategy simulates the action of buying a stock (or a futures) but at a fraction of the stock price. It is an inexpensive trade, similar in pay-off to Long Stock, except there is a gap between the strikes (please see the payoff diagram). As the stock price rises the strategy starts making profits. Let us try and understand Long Combo with an example.
For a small investment of Re. 1 (net debit), the returns can be very high in a Long Combo,but only if the stock moves up. Otherwise the potential losses can also be high.
STRATEGY 8 : PROTECTIVE CALL /SYNTHETIC LONG PUT
This is a strategy wherein an investor has gone short on a stock and buys a call to hedge. This is an opposite of Synthetic Call (Strategy 3). An investor shorts a stock and buys an ATM or slightly OTM Call. The net effect of this is that the investor creates a pay-off like a Long Put, but instead of having a net debit (paying premium) for a Long Put, he creates a net credit (receives money on shorting the stock). In case the stock price falls the investor gains in the downward fall in the price. However, incase there is an unexpected rise in the price of the stock the loss is limited. The pay-off from the Long Call will increase thereby compensating for the loss in value of the short stock position. This strategy hedges the upside in the stock position while retaining downside profit potential.
Example:
WHEN TO USE- If the investor is of the view that the market will is of go down but wants to protect against any unexpected rise in the price of the stock.
STRATEGY 9 : COVERED PUT This strategy is opposite to a Covered Call. A Covered Call is a neutral to bullish strategy, whereas a Covered Put is a neutral to Bearish strategy. You do this strategy when you feel the price of a stock / index is going to remain range bound or move down. Covered Put writing involves a short in a stock / index along with a short Put on the options on the stock/index. The Put that is sold is generally an OTM Put. The investor shorts a stock because he is bearish about it, but does not mind buying it back once the price reaches (falls to) a target price. This target price is the price at which the investor shorts the Put (Put strike price). Selling a Put means, buying the stock at the strike price if exercised (Strategy no. 2). If the stock falls below the Put strike, the investor will be exercised and will have to buy the stock at the strike price (which is anyway his target price to repurchase the stock). The investor makes a profit because he has shorted the stock and purchasing it at the strike price simply closes the short stock position at a profit. And the investor keeps the Premium on the Put sold. The investor is covered here because he shorted the stock in the first place.
If the stock price does not change, the investor gets to keep the Premium. He can use this strategy as an income in a neutral market . Let us understand this with an example .
STRATEGY 10 : LONG STRADDLE
A Straddle is a volatility strategy and is used when the stock price / index is expected to show large movements . This strategy involves buying a call as well as put on the same stock / index for the same maturity and strike price, to take advantage of a movement in either direction, a soaring or plummeting value of the stock / index. If the price of the stock/ index increases, the call is exercised while the put expires worthless and if the price of the stock / index decreases, the put is exercised, the call expires worthless. Either way if the stock / index shows volatility to cover the cost of the trade, profits are to be made. With Straddles, the investor is direction neutral. All that he is looking out for is the stock / index to break out exponentially in either direction.
Example:
SWAP
A swap is a contractual agreement between two parties to exchange cash flows. The cash flows that are swapped may be determined on the basis of interest rates, exchange rates, or the prices of indexes or commodities.Swap is usually customised and its market is considered an OTC. The salient features of swap are that:
It is a combination of forward contracts and it possesses all the properties of a forward contract;
swap is long term in nature, while forwards are arranged for short period only;
it requires that there is a double coincidence of wants, which is two parties with equal, opposite but matching needs must come into contact with each other; and
there may be a need for a financial intermediary to make the two counterparties meet.
There are different types of swaps, each with its own characteristics and the most common are:
(a) Interest rate/ Plain Vanilla Swap
An interest rate/ plain vanilla swap involve the exchange of a fixed rate loan to a floating rate loan. It has the effect of transforming a fixed rate loan into a floating rate loan or vice versa.
(b) Commodity Swap A commodity swap is a contract in which the counterparties agree to exchange cash flows that are determined on the basis of commodity prices.
(c) Currency Swap
A currency swap involves exchanging principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal loan in another currency. The counterparties to gain both interest rate exposure as well as foreign exchange exposure, as all payments are made in the counterparty's currency. An important distinction between an interest rate swap and a currency swap is that in the latter the principal amounts are typically exchanged on the origination date and at maturity.
(d) Equity Swap
An equity swap is an agreement in which counterparties pay and receive cash flows based on rates of return of a stock, basket of stocks or stock market index.
Swaps may be used to: (a) lower borrowing cost; (b) access New Financial Markets; (c) hedge risks; (d) correct asset-liability mismatch; or
(e) earn additional income.
DATA ANALYSIS
DATA ANALYSIS AND INTERPRETATION
INDIAN FINANCIAL DERIVATIVE MARKET
INDIAN derivative markets have achieved a drastic success for its advancement in different peculiar sectors and attract s investor s more and more for investing.
Apart from that particularly in this section we have to analyse what actually derivative market and how an investor can easily enter into it and invest wisely and earned an income without unlimited risk of loss.
Besides traditional financial markets two more markets are emerging namely the derivative market recently and bancassurance market, which is likely very important way once banks start undertaking insurance business derivatives in India are recently barring trade in forward contracts in forex markets .futures market in commodity segment however have existed for a long time . Recently Over the Counter (OTC) as well as EXCHANGE TRADED DERRIVATIVES have been introduced marking an important structure in Indian financial market. This offers a greater liquidity than OTC contracts and is negotiated between counter parties and tailor and also offer centralised limits on individual positions. In India, OTC derivatives, viz., Interest rate swaps (IRS) and Forward rate agreements (FRA) were introduced in july 1999 while an ETD viz., stock index futures was introduced by two largest stock exchanges in June 2000.The IRS and FRA were introduced with a view to deepening the money market as also enable banks, primary dealers and financial institutions to hedge interest rate risk.
In Indian market accounting for nearly all of the 928 deals, amounting to 12620 crore of notional principal as on November 17, 2000. Forward contracts also has emerged as an important segment of the fore x market.
The most notable development in secondary segment of Indian capital market is the introduction of derivatives trading in June 2000.SEBI approved derivatives trading based on futures contracts at both BSE and NSE in accordance with rules and regulations of the stock exchanges. Trading in index derivatives involves low transaction cost in comparison with underlying stocks. While the BSE introduced stock index futures for BSE SENSEX comprising 30scrips, the NSE introduced stock index futures for S&P CNX nifty comprising 50 scrips .As of now index futures on S&P nifty and CNXIT, INDEX OPTION on CNX nifty and CNXIT and futures on 52 individual securities band option on 52 individual securities specified by SEBI are available in NSE. To effectively manage risk in the derivative segment adequate risk containing measures have been put in place, which require s net worth of brokers and its composition, margining system based on 99 percent Value at risk (VaR)
Some of the extra factors behind securities derivative market have been discussed below.
In derivative trading process scrip that are being traded in lots In derivative by giving only margin money a huge volume of trade can be carried out. Through this activity hedging activity can be done by taking off setting position.
Derivative Turnover
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1,000,000
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3,000,000
4,000,000
5,000,000
6,000,000
7,000,000
Client Statistics for the Month:June 2015
No Of Clients
Apart from all, people with risk adverse attitude always prefer a risk free area for investment with slow and low rate of return. But the flavour presents in derivative is really interesting. So this critical report is based on “HOW TO GUIDE INVESTORS IN DERIVATIVE MARKET” will definitely help the investors in derivative segment because it will provide a unique theme of concept and strategies for derivative trading.
As we discussed a small amount of premium is paid to enter into derivative segment. So in derivative chance of risk of loss is high as well as possibility of gain is also high due to high volatility. Hence it needs a little bit analysis, as a result of which investor s can earn like anything. Derivative is a instrument basically used for hedging purposes. hence this study focuses on applying strategies in different market situations like purely bullish and bearish, mildly bullish and bearish, zero volatility, and strategies like butterfly, protective call etc., Which helps investors to earn unlimited profits with limited risk.
Some basic rules for derivative market... ..
Stay away from deep in the money options. Stay away from deep out of the money options. Trade slightly OTM, ATM or slightly ITM options. Know your market. Use options to hedge profitable future positions.
Some secrecy of success in options....:-
When market is CHEAP or EXPENSIVE there probably is reason. Have a plan before trade, and then work it! Money management is the key. Success comes easier when you specialise. Patience pays! The market’s reaction to the news is crucial. Never trade when sick or tired. Overtrading is one of your greatest enemies. Diversify.
DATA ANALYSIS
For the study the data are collected from primary sources and secondary sources. For the study there are several techniques are used to represent the data. I will represent my project using the following techniques.
Sampling:
Sampling refers to the method of selecting a limited no. of data from a given source with a view to draw conclusions about that source. A sample is a representative of the whole data for the study.
Sample size:
The sample size for my study will be the company.
Sampling technique:
Random sampling technique will be used in the survey conducted.
Whole companies are not taken into the preparation of the study.
Plan of analysis:
Tables will be used for the analysis of the collected data. The data is also neatly presented with the help of statistical tools. Percentages and averages have also been used to represent data clearly and effectively.
CRITICAL REVEIW OF QUESTIONAIRE
The total no of samples taken is 50. Basically the samples were taken from Bhubaneswar market.
AGE GROUP NO. OF PERSON PERCENTAGE
Below 25 8 16
25-35 15 30
35-45 20 40
45-60 4 8
60&above 3 6
Total 50 100
Graphically been shown as:
Interpretation: 40 % of the respondents fall under the age category of 35 – 45 years, 30 % of
them fall under 25-35 years were as 16 % of the respondents are between the age category of
below 25 and 8 % of the respondents are Between the age group of 45 – 60 years & 6 % of the
respondents falls under the age of 60 & above.
2. The following depicts the occupation of the respondents that are being taken
OCCUPATION NO OF PERSONS PERCENTAGE
STUDENT 10 20
GOVT. PROFESSIONAL
7 14
PVT.PROFESSIONAL
15 30
BUSINESS MEN 15 30
RETIRED 3 6
TOTAL 50 100
Graphically been shown as:
Below 25 25-35 35-45 45-60 60 & above0
5
10
15
20
25
30
35
40
45
NO. OF PERSONPERCENTAGE
STUDEN
T
GOVT PROFE
SSIO
NAL
PVT. PROFE
SSIO
NAL
BUSINES
S MEN
RETIRED
05
101520253035
NO. OF PERSONSPERCENTAGE
Interpretation: From the above chart it is clear that 30 % of the respondent are Business Men
and Private Employees each, Next are Student with a total of 20% and Govt Professionals being
14 % and Retired Employees 6 %.
3. The following depicts the monthly savings of the respondents that are being taken.
INTERPRETATION: 46 % of the respondents have monthly savings between 5000 – 10,000
/- were as respondents having savings of 10000-15000 are 36% , Below 5000 are 12 % and 6%
of respondents have monthly saving of 15000 & above.
4. The following shows the preference of savings of the respondents that are being taken.
PREFERENCE OFSAVINGS
NO. OF PERSONS
PERCENTAGE
Bank 20 40
Mutual fund 13 26
Postal10 20
Securities 7 14
TOTAL 50 100
Graphically been shown as:
Bank Mutual fund Postal Securities0
5
10
15
20
25
30
35
40
No. Of personsPercntage
INTERPRETATION: This chart gives a clear picture that till now the mentality of preferring Saving in banks doesn’t change. 40 % of respondents preferred Bank as their saving channel, 26 % of respondent prefer Mutual fund while 20 % in Postal & 14% on Securities.
5 The following shows the percentage of monthly household income one invest in Derivatives :
Percentage of Monthly Household income one invest
No. of Persons Percentage of Person
Below 5% 16 32
5% - 10% 22 44
11%-15% 8 16
16%- 20% 4 8
Total 50 100
Below 5% 5% - 10% 11%-15% 16%- 20%0
5
10
15
20
25
30
35
40
45
50
No. of PersonsPercentage of Person
INTERPRETATION: 44% of the respondents invest between 5-10 % of the monthly household
income in Derivatives, were as 32 % of the respondents would invest below 5% and 16% of the
respondents invest between 11-15 % in Derivatives Market. And around 8% of respondents invest
between 16-20% of their monthly household income Derivative Market.
6 . Purpose of Investors Investing in Derivatives Market:
Purpose No. of Persons Percentage
To Hedge Funds 17 34
Risk Control 15 30
Stable Income 11 22
Direct Investment 7 14
Total 50 100
Graphically been shown as:
To Hedge Funds Risk Control Stable Income Direct Investment0
5
10
15
20
25
30
35
40
No. of Persons Percentage
INTERPRETATION: 34% of the respondents invest in Derivatives to hedge funds, 30% of them
invest for risk control, 22% of the respondents for stable income and 14% invest as a direct
investment.
7. Participation in different type of Derivative instrument:
FINDINGS
As the data so collected from the market through survey, and it is found that more and more people have now facing towards capital market rather normal savings by the passage of the time basically in derivative segment.
As derivatives have also two instruments such as futures and options .these two instruments are mainly used for hedging purposes. People also more involved in future trading than options .cause are as follows
Most of the students and job holders they didn’t hear the word OPTION they found the con concept more complicated.
Most of the people are not aware of the risks associated with option market. I found another thing the students and executives who are related with financial
institutions only they know about trading in derivative. The most important thing is availability of inefficient advisory services regarding
derivative market as there involved high volatility. People don’t involve in option market because some stock broking houses are charging
high brokerage.
SUGGESTIONS
During this 45 days of study what i felt about the market is lacking want to suggest that.
As interest swaps reduce the exchanges rate risk, so swaps are very useful for Indian traders.
As there is no separate exchange for futures so SEBI must take certain initiatives for that. As options are quietly costly so options are not in existence. Investors are not properly aware of the Risk Management Systems, so proper RMS must
be taught through trainers.
CONCLUSION
The study so conducted on how to guide investors in derivative market and within these 45 days i realised that hoe derivative market operates. The text book theory and its practical application are quite exciting. And from these 42 days of study I am able to conclude that.
People of India are less involved in trading activities, basically less in derivative segment. People of India are less capable of assessing the risks involved in derivative market. No separate exchange for futures like in London. People are less experienced and efficient and less use of strategies. The RBI has planned for a phased introduction of currency futures and options. For the development of the currency market there need to be some institutional
development. In options cross currency options are allowed since they are quit costly as compared to
