INDIAN STOCK MARKET DERIVATIVES

INTRODUCTION TO DERIVATIVES The main instruments under the derivatives are: 1. Forward contract 2. Future contract 3. Options 4. Swaps

DEVELOPMENT OF DERIVATIVES MARKET IN INDIA Business growth of futures and options market: NSE Turnover (Rs.cr) Month Index futures Stock futures Index options Stock optionsTotal Jun Sep Dec Mar Jun Sep Dec Mar

Instruments available in India ProductsIndex FuturesIndex Options Futures on Individual Securities Options on Individual Securities Underlying Instrument S&P CNX Nifty 31 securities stipulated by SEBI TypeEuropeanAmerican Trading Cycle maximum of 3-month trading cycle. At any point in time, there will be 3 contracts available : 1) near month, 2) mid month & 3) far month duration Same as index futures Expiry Day Last Thursday of the expiry month Same as index futures Contract Size Permitted lot size is 200 & multiples thereof Same as index futures As stipulated by NSE (not less than Rs.2 lacs)

OPTIONS The Parties to an Option The options are of two styles. 1) European option and 2) American option The options are of two types. 1) Call option and 2) Put option.

In-the-Money, At-the-Money, Out-the- Money CALL OPTIONPUT OPTION In-the-moneyStrike price < Spot priceStrike price > Spot price At-the-moneyStrike price = Spot price Out-the-moneyStrike price > Spot priceStrike price < Spot price

Option value Intrinsic value and Time value.

Factors affecting the value of an option FactorOption TypeImpact on Option Value Component of Option Value Share price moves upCall OptionOption Value will also move upIntrinsic Value Share price moves downCall OptionOption Value will move downIntrinsic Value Share price moves upPut OptionOption Value will move downIntrinsic Value Share prices moves downPut OptionOption Value will move upIntrinsic Value Time to expire is highCall OptionOption Value will be highTime Value Time to expire is lowCall OptionOption Value will be lowTime Value Time to expire is highPut OptionOption Value will be highTime Value Time to expire is lowPut OptionOption Value will be lowTime Value Volatility is highCall OptionOption Value will be highTime Value Volatility is lowCall OptionOption Value will be lowTime Value Volatility is highPut OptionOption Value will be highTime Value Volatility is lowPut OptionOption Value will be lowTime Value

OPTIONS ON NIFTY & INDIVIDUAL SECURITIES Trading cycle Expiry day Strike Price Intervals Contract size

DERIVATIVES TRADING STRATEGIES USING OPTIONS Classification Of Strategies According To Market View When market to be bullish: Buy index/ stock futures Buy call option Sell put option Bull call spread Bull put spread Bullish calendar spread When market to be bearish: Sell index/ stock futures Sell call option Buy put option Bear call spread Bear put spread Bearish calendar spread

When market to be uncertain but expects to move in either direction sharply: Long straddle Long strangle Covered call Strips Straps When market to remain stable : Short straddle Short strangle Butterfly spreads Neutral calendar spread

BULL CALL SPREAD: buy a call and sell a call with different strike price and same expiry date with sell call strike price higher than the buy call strike price. 140 BEP= 142 ProfitProfit LossLoss Profit/loss of Long call Profit/loss of Short call Example: Assumptions: Spot price of ACC - Rs 142, Mutiplier : 1500 Buy ACC April 140 Rs 6 & Sell ACC April 150 Rs 4 Break-even point: Rs 142 There are four scenarios at the expiry date: ACC <= 140. Loss = Rs 3000 (limited to the extent of premium paid - premium received) ACC > 140 and <=142. Loss= (142–closing spot price at expiry)*1500 ACC>142 and <=150. Profit= (closing spot price at expiry–142)*1500 ACC > 150. Profit = (150 – 142) * 1500 Limited risk: since the loss can be maximum to the extent of net premium paid. Limited Profit: maximum being the difference between higher strike price option and lower strike price option after deducting the net premium paid.

ProfitProfit LossLoss Profit/loss of Long call Profit/loss of short call BEAR CALL SPREAD : Buy a call and sell a call with different strike price and same expiry date with sell call strike price lower than the buy call strike price. Example: Assumptions: Spot price of ACC - Rs 142 Sell ACC April 140 Rs 6 & Buy ACC April 150 Rs 4 Mutiplier : 1500 Break-even point: Rs 142 There are four scenarios at the expiry date: ACC <= 140. Profit = Rs 3000 (limited to the extent of premium received - premium paid) ACC>140 and <=142. Profit=(142–closing spot price at expiry) * 1500 ACC>142 and <=150. Loss=(closing spot price at expiry–142) * 1500 ACC > 150. Loss = (150 – 142) * 1500 Limited risk: since the loss can be maximum of Rs Limited Profit: maximum being the difference between premium received and premium paid.

ProfitProfit LossLoss Long CallLong Put LONG STRANGLE: Buy a call and buy a put with same expiry date but different strike price, with the put strike price lower than the call strike price and when one is uncertain about the market but expects it to move in either direction sharply. Example: Assumptions : Spot price of the ACC – Rs 145, Multiplier : 1500 Buy ACC Sep & Buy ACC Sep Break-even point : Rs 155 for call option/ Rs 135 for put option There are five scenarios at the expiry date. ACC <= 135 profit = (135- closing price at expiry)*1500 ACC > 135 & <= 140. Loss = (colsing price at expiry -135)*1500 ACC >140 & <=150 Loss = maximum to the extent of premium paid = Rs 7500 ACC>150 & <155. Loss= (155- closing spot price at expiry)*1500 ACC>= 155. Profit = (closing price at expiry –155)*1500 Limited risk: since loss can be limited to the extent of premium paid. Returns : unlimited as the maximum gain could be greater if sharp movement occur.

SHORT STRADDLE: Sell a call and sell a put with the same strike price and same expiry date when prices are expected to be stable. ProfitProfit LossLoss Sell CallSell Put Example Assumptions: Multiplier: 1600 Sell Tata Sept & Sell Tata Sept Break-even point : 157 for call option/ 123 for put option Tata <=123 loss = (123- closing at expiry)*1600 Tata> 123 & <=140. profit = ( closing at expiry - 123)*1600 Tata > 140 & <= 157. Profit = ( 157 – closing spot price at expiry)*1600 Tata >157. Loss = (closing spot price at expiry - 157)*1600 Risk: the maximum risk could be greater if sharp movements occur. Limited profit: since profit can be limited to the extent of premium received. Max. profit is Rs (17*1600) at a price of 140

Put/Call Ratio UncertainGreater than 0.35 and less than 0.75 Extremely bearishGreater than 0.75 Extremely bullishLess than 0.35 IndicationP/C ratio

OPEN INTEREST (An indicator) Some interpretations using Open Interest : Rising open interest in an uptrend is bullish Declining open interest in an uptrend is bearish. Rising open interest in a downtrend is bearish. Declining open interest in a downtrend is bullish. Within an uptrend, a sudden leveling off or decline in open interest often warns a change in trend. Very high open interest at market tops is dangerous and can intensify downside pressure.

FUTURES Only the sellers have to put in margins. Both the parties have to put in margins. Impose obligations on the sellers only. Impose obligations on both the parties The buyers have to pay a premium to the sellers. There is no premium Risk exposure and profit potential are limited for the seller. Risk exposure and profit potential are unlimited for both the parties. OptionsFutures DIFFERENCE BETWEEN FUTURES AND OPTIONS

Types of Futures Agricultural Metallurgical Interest Bearing Assets Indexes Foreign Currencies

Margin Money Different Types of Margins: Initial Margin Mark-to-Market Margin Maintenance Margin Additional Margin Cross Margining

THE BLACK -SCHOLES MODEL (An option pricing model)

FINDINGS Growth: Cash market- turnover-3692 cr. (BSE & NSE) Derivatives market- traded value cr. Factors that hinder the growth of Derivatives Market in India: Market is dominated by few large players. Very high minimum contract size. Initial investment. Number of scrips available for trading is 31. Cash settlement only.

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