1

1.1 INTRODUCTION
The term "DERIVATIVE" indicates the value which is entirely "derived" from
the value of the asset such as securities, commodities, bullion, currency, live stock or
anything else. In other words, Derivative means a forward, future, option or any other
hybrid contract of pre determined fixed duration, linked for the purpose of contract
fulfillment to the value of a specified real or financial asset or to an index of
securities.
Derivatives have been included in the definition of Securities in The
Securities Contracts (Regulations) Act, as a security derived from a debt instrument,
share, loan, whether secured or unsecured, risk instrument or contract for differences
or any other form of security; a contract which derives its value from the prices, or
index of prices, of underlying securities.
They include options and futures. Certain options are short-term in nature
and are issued by investors. These options may be long-term in nature and are issued
by companies in the process of financing their activities. The trading in derivatives are
things of US origin and in US the Organized exchanges began trading in options on
equities in 1973 and on debt from 1982.
The emergence of the market for derivative products, most notably
forwards, futures and options, can be traced back to the willingness of risk-averse
economic agents to guard themselves against uncertainties arising out of fluctuations
in asset prices. By their very nature, the financial markets are marked by a very high
degree of volatility. Through the use of derivative products, it is possible to partially
or fully transfer price risks by locking-in asset prices. As instruments of risk

2
management, these generally do not influence the fluctuations in the underlying asset
prices. However, by locking-in asset prices, derivative products minimize the impact
of fluctuations in asset prices on the profitability and cash flow situation of risk-
averse investors.
Products initially emerged, as hedging devices against fluctuations in
commodity prices and commodity-linked derivatives remained the sole form of such
products for almost three hundred years. The financial derivatives came into spotlight
in post-1970 period due to growing instability in the financial markets. However,
since their emergence, these products have become very popular and by 1990s, they
accounted for about two-thirds of total transactions in derivative products. In recent
years, the market for financial derivatives has grown tremendously both in terms of
variety of instruments available, their complexity and also turnover. In the class of
equity derivatives, futures and options on stock indices have gained more popularity
than on individual stocks, especially among institutional investors, who are major
users of index-linked derivatives. Even small investors find these useful due to high
correlation of the popular indices with various portfolios and ease of use. The lower
costs associated with index derivatives Vis derivative products based on individual
securities is another reason for their growing use.
1.2 OBJECTIVES OF THE STUDY
To analyze the operations of futures and options in India.
To find the profit/loss position of future buyer and seller and also the option
writer and option holder.
To study the risk management with the help of derivatives.

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1.3 SCOPE OF THE STUDY
The study is limited to TOOLS with special reference to futures
and options in Indian context and the inter-connected stock exchange has been taken
as a representative sample for the study. The study has only made a humble attempt at
evaluation derivatives market only in Indian context. The study is not based on the
international perspective of derivatives markets, which exists in NASDAQ, CBOT,
etc.
1.4 NEED FOR THE STUDY
In recent times the Derivatives have gained importance in
terms of their vital role in the economy. The increasing investments in derivatives
(domestic as well as overseas) have attracted my interest in this area. Through the use
of derivative products, it is possible to partially or fully transfer price risks by
looking-in asset prices. As the volume of trading is tremendously increasing in
derivatives market, this analysis will be of immense help to the investors.
1.5 RESEARCH METHEDOLOGY
DATA COLLECTION
For any statistical enquiry the collection of data or information is
done through principle sources identically i.e., by secondary sources of data.
Secondary data
Various portals,
www.nseindia.com

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1.6 HYPOTHESIS
In this section, I develop a stylized equilibrium model to analyze the eects of margin
requirements on banks welfare, default risk and on their trading volume in
derivatives contracts. I consider two banks with symmetric endowments yielding
uncertain payos. The banks can trade a derivatives contract with each other to hedge
their endowment. However, the nancial market is incomplete due to asymmetric
information. In order to reduce the burden created by idiosyncratic uninsurable
shocks, I allow banks to default on their obligations from derivatives trading. I then
introduce a margin requirement aimed at reducing default risk related to the trading of
the derivatives contract. Subsequently, I use the results obtained in this analysis to
derive a set of hypotheses about the impact of margin requirements on banks welfare,
default risk and on aggreagte derivatives tradingvolume that I then test within a more
realistic simulated market model.
I consider an economy consisting of two groups of banks5 with an initial
endowment of w0 > 0 units of a consumption good. I assume that banks behave as if
they maximized expected utility of terminal wealth having a common strictly
increasing, strictly concave utility function u( ). There are two dates. At date 1, banks
can trade in a derivatives contract. At date 2, one of two equally probable observable
states of the world, s1 and s2, occurs. In each state, one bank receives an endowment
of x units of the consumption good. The other bank typically receives a larger
endowment y. However, each of the banks has a small probability of receiving z < x
instead of the larger endowment y. The occurrence of this bad draw is private
information and independent across banks.6
Table A.1 summarizes the structure of uncertainty and endowments in our
economy. I initially assume y > x > z > 0.

5
Each bank mirrors the other and therefore expected aggregate endowment in this
economy is constant. I assume the marginal utility in the state in which a bank
receives the certain endowment x is higher than expected marginal utility in the state
in which it receives an uncertain endowment.
Assumption 1:- u (wx) > u (wy ) + (1 )u (wz ),
where w = w0+ with = x, y, z. Assumption 1 suggests that in equilibrium a bank
would thus buy derivatives contracts that transfer wealth to the state in which it
receives the certain endowment x.
















6
LITERATURE REVIEW
The product whose value is derived from the value of one or more basic
variables, called bases (underlying asset, index, or reference rate), in a contractual
manner. The underlying asset can be equity, forex, commodity or any other asset. For
example, wheat farmers may wish to sell their harvest at a future date to eliminate the
risk of a change in prices by that date. Such a transaction is an example of a
derivative. The price of this derivative is driven by the spot price of wheat which is
the underlying. In the Indian context the Securities Contracts (Regulation) Act,
1956 (SC(R) A) defines equity derivative to include
1. A security derived from a debt instrument, share, loan whether secured or
unsecured, risk instrument or contract for differences or any other form of security.
2. A contract, which derives its value from the prices, or index of prices, of
underlying securities.
The derivatives are securities under the SC(R) A and hence the trading of
derivatives is governed by the regulatory framework under the SC(R) A.1

The following factors have been driving the growth of financial derivatives:
1. Increased volatility in asset prices in financial markets,
2. Increased integration of national financial markets with the international markets,
3. Marked improvement in communication facilities and sharp decline in their costs,
4. Development of more sophisticated risk management tools, providing economic
agents a wider choice of risk management strategies, and

7
5. Innovations in the derivatives, which optimally combine the risks and returns over a
large number of financial assets, leading to higher returns, reduced risk as well as
trans-actions costs as compared to individual financial assets.
DERIVATIVES
Derivatives broadly can be classified into two categories, those that are traded on the
exchange and the/ those traded one to one or over the counter. They are hence
known as
Exchange Traded Derivatives
OTC Derivatives (Over The Counter)
Derivatives today
The prohibition on options in SCRA was removed in 1995. Foreign currency
options in currency pairs other than Rupee were the first options permitted by
RBI.
The Reserve Bank of India has permitted options, interest rate swaps, currency
swaps and other risk reductions OTC derivative products.
Besides the Forward market in currencies has been a vibrant market in India
for several decades.
In addition the Forward Markets Commission has allowed the setting up of
commodities futures exchanges. Today we have 18 commodities exchanges
most of which trade futures.
e.g. The Indian Pepper and Spice Traders Association (IPSTA) and the Coffee
Owners Futures Exchange of India (COFEI).

8
In 2000 an amendment to the SCRA expanded the definition of securities to
included Derivatives thereby enabling stock exchanges to trade derivative
products.
The year 2000 will herald the introduction of exchange traded equity
derivatives in India for the first time.

OTC Equity Derivatives
Traditionally equity derivatives have a long history in India in the OTC
market.
Options of various kinds (called Teji and Mandi and Fatak) in un-organized
markets were traded as early as 1900 in Mumbai
The SCRA however banned all kind of options in 1956.
Equity Exchanges in India
In the equity markets both the National Stock Exchange of India Ltd. (NSE)
and The Stock Exchange, Mumbai (BSE) have applied to SEBI for setting up
their derivatives segments.
The exchanges are expected to start trading in Stock Index futures by mid-
May 2000.
BSE's and NSEs plans
Both the exchanges have set-up an in-house segment instead of setting up a
separate exchange for derivatives.
BSEs Derivatives Segment, will start with Sensex futures as its first
product.

9
NSEs Futures & Options Segment will be launched with Nifty futures as the
first product.
Product Specifications BSE-30 Sensex Futures
Contract Size - Rs. 50 times the Index
Tick Size - 0.1 points or Rs. 5
Expiry day - last Thursday of the month
Settlement basis - cash settled
Contract cycle - 3 months
Active contracts - 3 nearest months
Product Specifications S&P CNX Nifty Futures
Contract Size - Rs. 200 times the Index
Tick Size - 0.05 points or Rs. 10
Expiry day - last Thursday of the month
Settlement basis - cash settled
Contract cycle - 3 months
Active contracts - 3 nearest months
Derivative players:
Hedgers: The objective of these kinds of traders is to reduce the risk. They are not in
the derivatives market to make profits. They are in it to safeguard their existing
positions. Apart from equity markets, hedging is common in the foreign exchange
markets where fluctuations in the exchange rate have to be taken care of in the foreign
currency transactions or could be in the commodities market where spiraling oil prices

10
have to be tamed using the security in derivative instruments.

Speculators: They are traders with a view and objective of making profits. They are
willing to take risks and they bet upon whether the markets would go up or come
down.

Arbitrageurs: Riskless Profit Making is the prime goal of Arbitrageurs. Buying in
one market and selling in another, buying two products in the same market are
common. They could be making money even without putting there own money in and
such opportunities often come up in the market but last for very short timeframes.
This is because as soon as the situation arises arbitrageurs take advantage and
demand-supply forces drive the markets back to normal.








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New System Vs Existing System for Derivative Players:
SPECULATORS

Existing SYSTEM New

Approach Peril &Prize Approach Peril &Prize
1) Deliver based 1) Both profit & 1) Buy &Sell stocks 1)Maximum
Trading, margin loss to extent of on delivery basis loss possible
trading& carry price change. 2) Buy Call &Put to premium
forward transactions. by paying paid
2) Buy Index Futures premium
hold till expiry.

Advantages
Greater Leverage as to pay only the premium.
Greater variety of strike price options at a given time.




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ARBITRAGEURS

Existing SYSTEM New

Approach Peril &Prize Approach Peril &Prize
1) Buying Stocks in 1) Make money 1) B Group more 1) Risk free
one and selling in whichever way the promising as still game.
another exchange. Market moves. in weekly settlement
forward transactions. 2) Cash &Carry
2) If Future Contract arbitrage continues
more or less than Fair price

Advantages
Fair Price = Cash Price + Cost of Carry.

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HEDGERS

Existing SYSTEM New

Approach Peril &Prize Approach Peril &Prize
1) Difficult to 1) No Leverage 1)Fix price today to buy 1) Additional
offload holding available risk latter by paying premium. cost is only
during adverse reward dependant 2)For Long, buy ATM Put premium.
market conditions on market prices Option. If market goes up,
as circuit filters long position benefit else
limit to curtail losses. exercise the option.
3)Sell deep OTM call option
with underlying shares, earn
premium + profit with increase prcie

Advantages
Availability of Leverage


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Participants and Functions
Three broad categories of participants - hedgers, speculators, and arbitrageurs - trade
in the derivatives market. Hedgers face risk associated with the price of an asset. They
use futures or options markets to reduce or eliminate this risk. Speculators wish to bet
on future movements in the price of an asset. Futures and options contracts can give
them an extra leverage; that is, they can increase both the potential gains and potential
losses in a speculative venture. Arbitrageurs are in business to take advantage of a
discrepancy between prices in two different markets. If, for example, they see the
futures price of an asset getting out of line with the cash price, they will take
offsetting positions in the two markets to lock in a profit.
The derivative market performs a number of economic functions. First, prices in an
organized derivatives market reflect the perception of market participants about the
future and lead the prices of underlying to the perceived future level. The prices of
derivatives converge with the prices of the underlying at the expiration of derivative
contract. Thus derivatives help in discovery of future as well as current prices.
Second, the derivatives market helps to transfer risks from those who have them but
may not like them to those who have appetite for them. Third, derivatives, due to their
inherent nature, are linked to the underlying cash markets. With the introduction of
derivatives, the underlying market witnesses higher trading volumes because of
participation by more players who would not otherwise participate for lack of an
arrangement to transfer risk. Fourth, speculative trades shift to a more controlled
environment of derivatives market. In the absence of an organized derivatives market,
speculators trade in the underlying cash markets. Margining, monitoring and
surveillance of the activities of various participants become extremely difficult in

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these kind of mixed markets. Fifth, an important incidental benefit that flows from
derivatives trading is that it acts as a catalyst for new entrepreneurial activity. The
derivatives have a history of attracting many bright, creative, well-educated people
with an entrepreneurial attitude. They often energize others to create new businesses,
new products and new employment opportunities, the benefit of which are immense.
Sixth, derivatives markets help increase savings and investment in the long run.
Transfer of risk enables market participants to expand their volume of activity.
Derivatives thus promote economic development to the extent the later depends on the
rate of savings and investment.




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Indian Market
Starting from a controlled economy, India has moved towards a world
where prices fluctuate every day. The introduction of risk management instruments in
India gained momentum in the last few years due to liberalization process and
Reserve Bank of Indias (RBI) efforts in creating currency forward market.
Derivatives are an integral part of liberalization process to manage risk. NSE gauging
the market requirements initiated the process of setting up derivative markets in India.
In July 1999, derivatives trading commenced in India

Table 2.1 Chronology of instruments

1991 Liberalisation process initiated
14 December 1995 NSE asked SEBI for permission to trade index futures.
18 November 1996 SEBI setup L.C.Gupta Committee to draft a policy framework
for index futures.
11 May 1998 L.C.Gupta Committee submitted report.
7 July 1999 RBI gave permission for OTC forward rate agreements (FRAs)
and interest rate swaps.
24 May 2000 SIMEX chose Nifty for trading futures and options on an Indian
index.
25 May 2000 SEBI gave permission to NSE and BSE to do index futures
trading.
9 June 2000 Trading of BSE Sensex futures commenced at BSE.
12 June 2000 Trading of Nifty futures commenced at NSE.
25 September 2000 Nifty futures trading commenced at SGX.
2 June 2001 Individual Stock Options & Derivatives


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Exchange-traded vs. OTC derivatives markets
The OTC derivatives markets have witnessed rather sharp growth over
the last few years, which has accompanied the modernization of commercial and
investment banking and globalization of financial activities. The recent developments
in information technology have contributed to a great extent to these developments.
While both exchange-traded and OTC derivative contracts offer many benefits, the
former have rigid structures compared to the latter. It has been widely discussed that
the highly leveraged institutions and their OTC derivative positions were the main
cause of turbulence in financial markets in 1998. These episodes of turbulence
revealed the risks posed to market stability originating in features of OTC derivative
instruments and markets.
The OTC derivatives markets have the following features compared to
exchange-traded derivatives:
1. The management of counter-party (credit) risk is decentralized and located
within individual institutions,
2. There are no formal centralized limits on individual positions, leverage, or
margining,
3. There are no formal rules for risk and burden-sharing,
4. There are no formal rules or mechanisms for ensuring market stability and
integrity, and for safeguarding the collective interests of market participants,
and
5. The OTC contracts are generally not regulated by a regulatory authority and
the exchanges self-regulatory organization, although they are affected

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indirectly by national legal systems, banking supervision and market
surveillance.
Some of the features of OTC derivatives markets embody risks to financial
market stability.
The following features of OTC derivatives markets can give rise to
instability in institutions, markets, and the international financial system: (i) the
dynamic nature of gross credit exposures; (ii) information asymmetries; (iii) the
effects of OTC derivative activities on available aggregate credit; (iv) the high
concentration of OTC derivative activities in major institutions; and (v) the central
role of OTC derivatives markets in the global financial system. Instability arises when
shocks, such as counter-party credit events and sharp movements in asset prices that
underlie derivative contracts, occur which significantly alter the perceptions of current
and potential future credit exposures. When asset prices change rapidly, the size and
configuration of counter-party exposures can become unsustainably large and provoke
a rapid unwinding of positions.
There has been some progress in addressing these risks and
perceptions. However, the progress has been limited in implementing reforms in risk
management, including counter-party, liquidity and operational risks, and OTC
derivatives markets continue to pose a threat to international financial stability. The
problem is more acute as heavy reliance on OTC derivatives creates the possibility of
systemic financial events, which fall outside the more formal clearing house
structures. Moreover, those who provide OTC derivative products, hedge their risks
through the use of exchange traded derivatives. In view of the inherent risks
associated with OTC derivatives, and their dependence on exchange traded
derivatives, Indian law considers them illegal.

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Types of derivatives
The most commonly used derivatives contracts are forwards, futures and options
which we shall discuss in detail later. Here we take a brief look at various derivatives
contracts that have come to be used.
Forwards: A forward contract is a customized contract between two entities, where
settlement takes place on a specific date in the future at todays pre-agreed price.
Futures: A futures contract is an agreement between two parties to buy or sell an
asset at a certain time in the future at a certain price. Futures contracts are special
types of forward contracts in the sense that the former are standardized exchange-
traded contracts.
Options: Options are of two types - calls and puts. Calls give the buyer the right but
not the obligation to buy a given quantity of the underlying asset, at a given price on
or before a given future date. Puts give the buyer the right, but not the obligation to
sell a given quantity of the underlying asset at a given price on or before a given date.
Swaps: Swaps are private agreements between two parties to exchange cash flows in
the future according to a prearranged formula. They can be regarded as portfolios of
forward contracts. The two commonly used swaps are:
I nterest rate swaps: These entail swapping only the interest related cash flows
between the parties in the same currency.
Currency swaps: These entail swapping both principal and interest between the
parties, with the cash flows in one direction being in a different currency than
those in the opposite direction.

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Warrants: Options generally have lives of upto one year, the majority of options
traded on options exchanges having a maximum maturity of nine months. Longer-
dated options are called warrants and are generally traded over-the-counter.
LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities.
These are options having a maturity of upto three years.
Baskets: Basket options are options on portfolios of underlying assets. The
underlying asset is usually a moving average or a basket of assets. Equity index
options are a form of basket options.
Swaptions: Swaptions are options to buy or sell a swap that will become operative at
the expiry of the options. Thus a swaption is an option on a forward swap. Rather than
have calls and puts, the swaptions market has receiver swaptions and payer swaptions.
A receiver swaption is an option to receive fixed and pay floating. A payer swaption
is an option to pay fixed and receive floating.
Introduction to futures:
Futures markets were designed to solve the problems that exist in forward
markets. A futures contract is an agreement between two parties to buy or sell an asset
at a certain time in the future at a certain price. But unlike forward contracts, the
futures contracts are standardized and exchange traded. To facilitate liquidity in the
futures contracts, the exchange specifies certain standard features of the contract. It is
a standardized contract with standard underlying instrument, a standard quantity and
quality of the underlying instrument that can be delivered, (or which can be used for
reference purposes in settlement) and a standard timing of such settlement. A futures

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contract may be offset prior to maturity by entering into an equal and opposite
transaction. More than 99% of futures transactions are offset this way.
The standardized items in a futures contract are: -
Quantity of the underlying
Quality of the underlying
The date and the month of delivery
The units of price quotation and minimum price change
Location of settlement
Futures Terminology
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the futures
market.
Contract cycle: The period over which a contract trades. The index futures
contracts on the NSE have one-month, two-months and three-months expiry
cycles, which expire on the last Thursday of the month. Thus a January expiration
contract expires on the last Thursday of January and a February expiration
contract ceases trading on the last Thursday of February. On the Friday following
the last Thursday, a new contract having a three-month expiry is introduced for
trading.
Expiry date: It is the date specified in the futures contract. This is the last day on
which the contract will be traded, at the end of which it will cease to exist.
Contract size: The amount of asset that has to be delivered under one contract.
For in-stance, the contract size on NSEs futures market is 200 Nifties.

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Basis: In the context of financial futures, basis can be defined as the futures price
minus the spot price. There will be a different basis for each delivery month for
each contract. In a normal market, basis will be positive. This reflects that futures
prices normally exceed spot prices.
Cost of carry: The relationship between futures prices and spot prices can be
summarized in terms of what is known as the cost of carry. This measures the
storage cost plus the interest that is paid to finance the asset less the income
earned on the asset.
Initial margin: The amount that must be deposited in the margin account at the
time a futures contract is first entered into is known as initial margin.
Marking-to-market: In the futures market, at the end of each trading day, the
margin ac-count is adjusted to reflect the investors gain or loss depending upon
the futures closing price. This is called markingtomarket.
Maintenance margin: This is somewhat lower than the initial margin. This is set
to ensure that the balance in the margin account never becomes negative. If the
balance in the margin account falls below the maintenance margin, the investor
receives a margin call and is expected to top up the margin account to the initial
margin level before trading commences on the next day.
Introduction to options
In this section, we look at the next derivative product to be traded on the
NSE, namely options. Options are fundamentally different from forward and futures
contracts. An option gives the holder of the option the right to do something. The
holder does not have to exercise this right. In contrast, in a forward or futures
contract, the two parties have committed themselves to doing something. Whereas it

23
costs nothing (except margin requirements) to enter into a futures contract, the
purchase of an option requires an upfront payment.
History of options
Although options have existed for a long time, they were traded OTC,
without much knowledge of valuation. Today exchange-traded options are actively
traded on stocks, stock indexes, foreign currencies and futures contracts. The first
trading in options began in Europe and the US as early as the eighteenth century. It
was only in the early 1900s that a group of firms set up what was known as the put
and call Brokers and Dealers Association with the aim of providing a mechanism for
bringing buyers and sellers together. If someone wanted to buy an option, he or she
would contact one of the member firms.
The firm would then attempt to find a seller or writer of the option either from its own
clients or those of other member firms. If no seller could be found, the firm would
undertake to write the option itself in return for a price. This market however suffered
from two deficiencies. First, there was no secondary market and second, there was no
mechanism to guarantee that the writer of the option would honor the contract. It was
in 1973, that Black, Merton and Scholes invented the famed Black Scholes formula.
In April 1973, CBOE was set up specifically for the purpose of trading options. The
market for options developed so rapidly that by early 80s, the number of shares
underlying the option contract sold each day exceeded the daily volume of shares
traded on the NYSE. Since then, there has been no looking back.



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Option Terminology
Index options: These options have the index as the underlying. Some options are
European while others are American. Like index futures contracts, index options
contracts are also cash settled.
Stock options: Stock options are options on individual stocks. Options currently
trade on over 500 stocks in the United States. A contract gives the holder the right
to buy or sell shares at the specified price.
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 of an option: The writer 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. There are two basic types of options, call options and put options. 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: Option price is the price which the option buyer pays to the option
seller.
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. Most exchange-traded options are American.

25
European options: European options are options that can be exercised only on
the expiration date itself. European options are easier to analyze than American
options, and properties of an American option are frequently deduced from those
of its European counterpart.
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 it 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. Putting it another way, the intrinsic value of a call isNP which means the
intrinsic value of a call is Max [0, (S
t
K)] which means the intrinsic value of a

26
call is the (S
t
K). Similarly, the intrinsic value of a put is Max [0, (K -S
t
)] ,i.e.
the greater of 0 or (K - S
t
). K is the strike price and S
t
is the spot price.
Time value of an option: The time value of an option is the difference between its
premium and its intrinsic value. A call 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 a calls time value, all else equal. At expiration, a call
should have no time value.
Futures and options
An interesting question to ask at this stage is - when would one use
options instead of futures? Options are different from futures in several interesting
senses.
At a practical level, the option buyer faces an interesting situation. He
pays for the option in full at the time it is purchased. After this, he only has an upside.
There is no possibility of the options position generating any further losses to him
(other than the funds already paid for the option). This is different from futures, which
is free to enter into, but can generate very large losses. This characteristic makes
options attractive to many occasional market participants, who cannot put in the time
to closely monitor their futures positions.
Buying put options is buying insurance. To buy a put option on Nifty
is to buy insurance, which reimburses the full extent to which Nifty drops below the
strike price of the put option. This is attractive to many people, and to mutual funds
creating guaranteed return products. The Nifty index fund industry will find it very
useful to make a bundle of a Nifty index fund and a Nifty put option to create a new

27
kind of a Nifty index fund, which gives the investor protection against extreme drops
in Nifty.
Distinction between futures and options
TABLE 2.2
Futures Options
Exchange traded, with novation Same as futures.
Exchange defines the product Same as futures.
Price is zero, strike price moves Strike price is fixed, price moves.
Price is zero Price is always positive.
Linear payoff Nonlinear payoff.
Both long and short at risk Only short at risk.
Source: http://www.derivativesindia/scripts/glossary/indexobasic.asp

Payoff & Pricing of Futures and Options
A payoff is the likely profit/loss that would accrue to a market participant with change
in the price of the underlying asset. This is generally depicted in the form of payoff
diagrams which show the price of the underlying asset on the Xaxis and the
profits/losses on the Yaxis. In this section we shall take a look at the payoffs for
buyers and sellers of futures and options.



28
Payoff for futures
Futures contracts have linear payoffs. In simple words, it means that the
losses as well as profits for the buyer and the seller of a futures contract are unlimited.
These linear payoffs are fascinating as they can be combined with options and the
underlying to generate various complex payoffs.
Payoff for buyer of futures: Long futures
The payoff for a person who buys a futures contract is similar to the payoff
for a person who holds an asset. He has a potentially unlimited upside as well as a
potentially unlimited downside.
Take the case of a speculator who buys a two-month Nifty index futures
contract when the Nifty stands at 1220. The underlying asset in this case is the Nifty
portfolio. When the index moves up, the long futures position starts making profits,
and when the index moves down it starts making losses. Figure 5.1 shows the payoff
diagram for the buyer of a futures contract.
Payoff for seller of futures: Short futures
The payoff for a person who sells a futures contract is similar to the payoff
for a person who shorts an asset. He has a potentially unlimited upside as well as a
potentially unlimited downside. Take the case of a speculator who sells a two-month
Nifty index futures contract when the Nifty stands at 1220. The underlying asset in
this case is the Nifty portfolio. When the index moves down, the short futures position
starts making profits, and when the index moves up, it starts making losses. Figure 5.2
shows the payoff diagram for the seller of a futures contract.

29



Payoff for a buyer of Nifty futures:
The figure shows the profits/losses for a long futures position. The investor bought
futures when the index was at 1220. If the index goes up, his futures position starts
making profit. If the index falls, his futures position starts showing losses.


Profit
1220
NIFTY
loss







30


Payoff for a seller of Nifty futures:
The figure shows the profits/losses for a short futures position. The investor
sold futures when the index was at 1220. If the index goes down, his futures position
starts making profit. If the index rises, his futures position starts showing losses.

Profit
1220
Nifty
loss
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, the payoff is
exactly the opposite. His profits are limited to the option premium, however his losses
are potentially unlimited.
These non-linear 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.


31
Payoff profile of buyer of asset: Long asset
In this basic position, an investor buys the underlying asset, Nifty for
instance, for 1220, and sells it at a future date at an unknown price,S
4
it is purchased,
the investor is said to be long the asset. Figure 5.3 shows the payoff for a long
position on the Nifty
Payoff for investor who went Long Nifty at 1220:
The figure shows the profits/losses from a long position on the index. The investor
bought the index at 1220. If the index goes up, he profits. If the index falls he looses.
Profit
+60
1160 1220 1280
-60 Nifty
Loss
Payoff profile for seller of asset: Short asset
In this basic position, an investor shorts the underlying asset, Nifty for
instance, for 1220, and buys it back at a future date at an unknown price Once it is
sold, the investor is said to be short the asset. Below figure shows the pay-off for a
short position on the Nifty.



32
Payoff for investor who went Short Nifty at 1220
The figure shows the profits/losses from a short position on the index.
The investor sold the index at 1220. If the index falls, he profits. If the index rises, he
looses

Profit
+60

0 1160 1220 1280 Nifty

-60
Loss

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

33
5.5 gives the payoff for the buyer of a three month call option (often referred to as
long call) with a strike of 1250 bought at a premium of 86.60.

Payoff profile for writer 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 buyers profit is the sellers 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 5.6 gives the payoff for the
writer of a three month call option (often referred to as short call) with a strike of
1250 sold at a premium of 86.60.
Payoff for buyer of call option:
The figure shows the profits/losses for the buyer of a three-month Nifty 1250 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 1250, 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 1250, he lets the option expire. His losses are limited to the extent
of the premium he paid for buying the option.


34
PROFIT

0 1250 Nifty
86.60
LOSS
Payoff for writer of call option
The figure shows the profits/losses for the seller of a three-month Nifty 1250
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 1250, 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.

Profit
86.60
0 1250 Nifty

Loss



35
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
5.7 gives the payoff for the buyer of a three month put option (often referred to as
long put) with a strike of 1250 bought at a premium of 61.70.
Payoff for buyer of put option:
The figure shows the profits/losses for the buyer of a three-month Nifty
1250 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 1250, 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 1250, he lets the option expire. His losses
are limited to the extent of the premium he paid for buying the option.
Profit

0 Nifty
61.70 1250
Loss

36

Payoff profile for writer 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 buyers profit is the sellers loss. If upon
expiration, the spot price happens to be below the strike price, the buyer will exercise
the option on the writer. If upon expiration the spot price of the underlying is more
than the strike price, the buyer lets his option expire un-exercised and the writer gets
to keep the premium. Figure 5.8 gives the payoff for the writer of a three-month put
option (often referred to as short put) with a strike of 1250 sold at a premium of
61.70.
Payoff for writer of put option:
The figure shows the profits/losses for the seller of a three-month Nifty
1250 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 1250, 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 Nifty-close. 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.
Nifty


37

Profit
61.70 1250

0 Nifty

Loss
The cost of carry model
We use fair value calculation of futures to decide the no-arbitrage limits on the price
of a futures contract. This is the basis for the cost-of-carry model where the price of
the contract is defined as:
F=S+C
Where:
F: Futures price
S: Spot price
C: Holding costs or carry costs
This can also be expressed as:
F=s (1+r)
T
Where:
r: Cost of financing
T: Time till expiration

38

If F < s (1+r)
T
or F > s (1+r)
T
, arbitrage opportunities would exist i.e. whenever the
futures price moves away from the fair value, there would be chances for arbitrage.
We know what the spot and future prices are, but what are the components of holding
cost? The components of holding cost vary with contracts on different assets. At times
the holding cost may even be negative. In the case of commodity futures, the holding
cost is the cost of financing plus cost of storage and insurance purchased etc. In the
case of equity futures, the holding cost is the cost of financing minus the dividends
returns.
Note: In the futures pricing examples worked out in this book, we are using the
concept of discrete compounding, where interest rates are compounded at discrete
intervals, for example, annually or semiannually. Pricing of options and other
complex derivative securities requires the use of continuously compounded interest
rates. Most books on derivatives use continuous compounding for pricing futures too.
However, we have used discrete compounding as it is more intuitive and simpler to
work with. Had we to use the concept of continuous compounding, the above
equation would have been expressed as:
F= Se
rT

Where:
r: Cost of financing (using continuously compounded interest rate)
T: Time till expiration
e: 2.71828

39
Pricing futures contracts on commodities
Let us take an example of a futures contract on a commodity and work out the price of
the contract. The spot price of silver is Rs.7000/kg. If the cost of financing is 15%
annually, what should be the futures price of 100 gms of silver one month down the
line ? Let us assume that were on 1st January 2001. How would we compute the
price of a silver futures contract expiring on 30th January? From the discussion above
we know that the futures price is nothing but the spot price plus the cost-of-carry. Let
us first try to work out the components of the cost-of-carry model.

1. What is the spot price of silver? The spot price of silver, S= Rs.7000/kg.
2. What is the cost of financing for a month? (1+0.15)
30/365

3. What are the holding costs? Let us assume that the storage cost = 0.
In this case the fair value of the futures price, works out to be = Rs.708.
F=s (1+r)
T
+ C = 700(1.15)
30/365
=Rs. 708
If the contract was for 3 month period i.e. expiring 30
th
March the
cost of financing would increase the futures price. Therefore, the futures price would
be C = 700(1.15)
90/365
= Rs.724.5. On the other hand, if the one-month contract was
for 10,000 kg. Of silver instead of 100 gms, then it would involve a non-zero storage
cost, and the price of the future contract would be Rs. 708 +the cost of storage.



40
COMPANY PROFILE
AXIS Bank is one of the fastest growing banks in private sector. The Bank
operates in four segments, namely treasury, retail banking, corporate/ wholesale
banking and other banking business. The treasury operations include investments in
sovereign and corporate debt, equity and mutual funds, trading operations, derivative
trading and foreign exchange operations on the account, and for customers and central
funding. Retail banking includes lending to individuals/ small businesses subject to
the orientation, product and granularity criterion. It also includes liability products,
card services, Internet banking, automated teller machines (ATM) services,
depository, financial advisory services, and non resident Indian (NRI) services. The
corporate/ wholesale banking segment includes corporate relationships not included
under retail banking, corporate advisory services, placements and syndication,
management of publics issue, project appraisals, capital market related services, and
cash management services. The Bank's registered office is located at Ahmedabad and
their Central Office is located at Mumbai. The Bank has a very wide network of more
than 1042 branches (including 56 Service Branches/ CPCs as on June 30, 2010). The
Bank has a network of over 4,474 ATMs providing 24 hrs a day banking convenience
to their customers. This is one of the largest ATM networks in the country. The Bank
has five wholly-owned subsidiaries namely Axis Securities and Sales Ltd, Axis
Private Equity Ltd, Axis Trustee Services Ltd, Axis Asset Management Company Ltd
and Axis Mutual Fund Trustee Ltd. Axis Bank was incorporated in the year 1993 with
the name UTI Bank Ltd. The Bank was the first private banks to have begun
operations after the Government of India allowed new private banks to be established.
The Bank was promoted jointly by the Administrator of the specified undertaking of
the Unit Trust of India (UTI - I), Life Insurance Corporation of India (LIC) and

41
General Insurance Corporation of India (GIC) and other four PSU insurance
companies, i.e. National Insurance Company Ltd, The New India Assurance
Company Ltd, The Oriental Insurance Company Ltd and United India Insurance
Company Ltd. In the year 2001, the bank along with Global Trust Bank (GTB) had a
merger proposal to create the largest private sector bank, but due to media's issues
both the banks withdraw the merger proposal. In the year 2003, the Bank was given
the authorized to handle Government transactions such as collection of Government
taxes, to handle the expenditure related payments of Central Government Ministries
and Departments and pension payments on behalf of Civil and Non-civil Ministries
such as defence, posts, telecom and railways. In December 20003, the Bank launched
their merchant acquiring business. In the year 2005, the Bank raised $239.3 million
through Global Depositary Receipts. They won the award 'Outstanding Achievement
Award' for the year 2005 from Indian Banks Association for IT Infrastructure,
delivery capabilities and innovative solutions. In December 2005, the Bank set up
Axis Securities and Sales Ltd (originally incorporated as UBL Sales Ltd) to market
credit cards and retail asset products. In October 2006, they set up Axis Private Equity
Ltd, primarily to carry on the activities of managing equity investments and provide
venture capital support to businesses. In the year of 2007, the bank again raised
$218.67 million through Global Depository Receipts. They opened 153 new branches
during the year, which includes 43 extension counters that have been upgraded to
branches and 8 Service branches/ CPCs. They also opened new overseas offices at
Singapore, Dubai and Hong Kong and a representative office in Shanghai. During the
year 2007-08, the Bank opened 143 new branches, taking the number of branches to
651 which included 33 extension counters that have been upgraded to branches. Also,
they expanded overseas with the opening of a branch at the Dubai International

42
Finance Centre. The Bank changed their name from UTI Bank Ltd to Axis Bank Ltd
with effect from July 30, 2007 to avoid confusion with other unrelated entities with
similar name. During the year 2008-09, the Bank opened 176 new branches that
include 12 extension counters that have been upgraded to branches taking the total
number of branches and ECs to 835. During the year, they opened 831 ATMs, thereby
taking the ATM network of the Bank from 2,764 to 3,595. Also, they opened a
Representative Office in Dubai. In May 2008, the Bank established Axis Trustee
Services Company Ltd as a wholly owned subsidiary company, which is engaged in
trusteeship activities. In December 2008, they launched their new investment advisory
service exclusively for High Net Worth clients. In January 2009, the Bank set up Axis
Asset Management Company Ltd to carry on the activities of managing a mutual fund
business. Also, they incorporated Axis Mutual Fund Trustee Ltd to act as the trustee
for the mutual fund business. During the year 2009-10, the Bank opened 200 branches
taking the total number of branches Extension Counters (ECs) to 1,035. In March
2009, 2010, they opened their 1000 branch at Bandra West, Mumbai. In September
2009, Axis Bank launched the private banking business in the domestic market,
christened 'Privee' to cater to highly affluent individuals and families offering them
unique investment opportunities During the year, the Capital Markets SBU was
restructured with the debt capital market business (hitherto a part of the capital
markets) carved into a separate vertical. As a result, the Bank's Capital Markets SBU
comprises equity capital markets (ECM) business, mergers and acquisitions and
private equity syndication. In February 24, 2010, the Bank launched the 'AXIS CALL
& PAY on atom', a unique mobile payments solution using Axis Bank debit cards.
Axis Bank is the first bank in the country to provide a secure debit card-based
payment service over IVR. During the year 2010-11, 407 new branches were added to

43
the Bank's network taking the total number of branches and extension counters (ECs)
to 1,390. Of these, 564 branches/ ECs are in semi-urban and rural areas and 826
branches/ECs are in metropolitan and urban areas. The Bank is present in all states
and Union Territories (except Lakshadweep) covering 921 centres. The ATM network
of the Bank increased from 4,293 to 6,270. During the year, the Bank also opened a
Representative Office in Abu Dhabi. This was in addition to the existing branches at
Singapore, Hong Kong and DIFC (Dubai International Financial Centre) and
representative offices at Shanghai and Dubai. In March 7, 2011, the Bank
incorporated a new subsidiary namely Axis U.K. Ltd. as a private limited company
registered in the United Kingdom (UK) with the main purpose of filing an application
with Financial Services Authority (FSA), UK for a banking license in the UK and for
the creation of necessary infrastructure for the subsidiary to commence banking
business in the UK.









44
FUTURES

ANALYSIS OF AXIS BANK:
The objective of this analysis is to evaluate the profit/loss position of futures. This
analysis is based on sample data taken of AXIS BANK scrip. This analysis considered
the MAR 2012 contract of AXIS BANK. The lot size of is AXIS BANK is 250, the
time period in which this analysis done is from 5-Mar-2012 to 3-Mar-2012.
Table 3.1
DATE MARKET PRICE FUTURE PRICE
5-Mar-2012 1168.8 1146.05
6-Mar-2012 1147.1 1152.4
7-Mar-2012 1142.15 1170.1
9-Mar-2012 1191 1213.5
12-Mar-2012 1236.5 1223.95
13-Mar-2012 1222 1243.85
14-Mar-2012 1257.9 1280.75
15-Mar-2012 1274.6 1241.15
16-Mar-2012 1243 1216.05
19-Mar-2012 1228.9 1204.4
20-Mar-2012 1207.2 1191.5
21-Mar-2012 1188.5 1238.1
22-Mar-2012 1239.8 1176.4
23-Mar-2012 1184 1183.7
26-Mar-2012 1176.55 1129.4
27-Mar-2012 1150.35 1143
28-Mar-2012 1130.8 1117.75
29-Mar-2012 1104.95 1124.8
30-Mar-2012 1129.65 1152.85
Source: www.nseindia.com



45





OBSERVATIONS AND FINDINGS:

If a person buys 1 lot i.e. 250 futures of AXIS BANK on 5-Mar-2012 and sell
on 29-Mar-2012 then he will get a loss of 1124.8 1146.05 = -21.25 per share, so he
will get a loss of 5312.5 i.e.(-21.25*250). If he sells on 30-Mar-2012 then he will
get a profit of 1152.85 -1146.05= 6.8 i.e. a profit of 6.8 per share, so his total profit is
1700 i.e. (6.8*250).
The closing price of AXIS BANK at the end of the contract period is 1152.85 and this
is considered as settlement price.

1000
1100
1200
1300
AXIS BANK
MARKET PRICE FUTURE PRICE

46
ANALYSIS OF HDFC BANK:

The objective of this analysis is to evaluate the profit/loss position of futures. This
analysis is based on sample data taken of HDFC BANK scrip. This analysis
considered the MAR 2012 contract of HDFC BANK. The lot size of is HDFC BANK
is 500, the time period in which this analysis done is from 5-Mar-2012 to 30-Mar-
2012.
Table 3.2
DATE MARKET PRICE FUTURE PRICE
5-Mar-2012 671.2 662.7
6-Mar-2012 659.05 656.8
7-Mar-2012 652.7 659.95
9-Mar-2012 666.75 683.25
12-Mar-2012 688.6 676.05
13-Mar-2012 679.3 687.45
14-Mar-2012 691 683.3
15-Mar-2012 680.3 667.2
16-Mar-2012 668.95 670.35
19-Mar-2012 671 653.75
20-Mar-2012 658.5 660.3
21-Mar-2012 660.7 670.45
22-Mar-2012 669.4 661.05
23-Mar-2012 664 661.95
26-Mar-2012 658.95 652.25
27-Mar-2012 657.55 666.85
28-Mar-2012 664.65 660.35
29-Mar-2012 655.85 664.8
30-Mar-2012 678.6 678.25
Source: www.nseindia.com


47




OBSERVATIONS AND FINDINGS:

If a person buys 1 lot i.e.500 futures of HDFC BANK on 5-Mar-2012 and sell
on 28-Mar-2012 then he will get a loss of 660.35 662.7 = -2.35 per share, so he will
get a loss of 1175 i.e.(-2.35*500). If he sells on 29-Mar-2012 then he will get a profit
of 664.8 662.7 = 2.1 i.e. a profit of 2.1 per share, so his total profit is 1050 i.e.
(2.1*500).
The closing price of HDFC BANK at the end of the contract period is 664.8 and this
is considered as settlement price.



630
640
650
660
670
680
690
700
HDFC BANK
MARKET PRICE FUTURE PRICE

48

ANALYSIS OF ICICI BANK:

The objective of this analysis is to evaluate the profit/loss position of futures. This
analysis is based on sample data taken of ICICI BANK scrip. This analysis considered
the MAR 2012 contract of ICICI BANK. The lot size of ICICI BANK is 250, the time
period in which this analysis done is from 5-Mar-2012 to 30-Mar-2012.
Table 3.3
DATE MARKET PRICE FUTURE PRICE
5-Mar-2012 905 879.3
6-Mar-2012 874.4 861.05
7-Mar-2012 856.35 869.75
9-Mar-2012 884.65 918.88
12-Mar-2012 937.55 933.25
13-Mar-2012 939.6 938
14-Mar-2012 951.15 962.75
15-Mar-2012 960 936.75
16-Mar-2012 942 921.8
19-Mar-2012 932.5 912.5
20-Mar-2012 912.8 913.85
21-Mar-2012 908.75 941
22-Mar-2012 943.3 901.7
23-Mar-2012 910 912.25
26-Mar-2012 907 874.55
27-Mar-2012 889.1 880.05
28-Mar-2012 877.15 859.5
29-Mar-2012 852.75 856.45
30-Mar-2012 867.25 890.9
Source: www.nseindia.com



49





OBSERVATIONS AND FINDINGS:

If a person buys 1 lot i.e. 250 futures of ICICI BANK on 5-Mar-2012 and sell
on 30-Mar-2012 then he will get a loss of 890.9 879.3=11.6 per share, so he will
get a Profit of 2900 i.e. (11.6*250).
The closing price of ICICI BANK at the end of the contract period is 890.9 and this is
considered as settlement price.



750
800
850
900
950
1000
ICICI BANK
MARKET PRICE FUTURE PRICE

50

ANALYSIS OF YES BANK:

The objective of this analysis is to evaluate the profit/loss position of futures. This
analysis is based on sample data taken of YES BANK scrip. This analysis considered
the MAR 2012 contract of YES BANK. The lot size of is YES BANK is 1000, the
time period in which this analysis done is from 5-Mar-12 to 30-Mar-12.
Table 3.4
DATE MARKET PRICE FUTURE PRICE
5-Mar-2012 350.05 341.45
6-Mar-2012 338.6 342.3
7-Mar-2012 340.3 340.5
9-Mar-2012 345.4 364.25
12-Mar-2012 371.5 366.7
13-Mar-2012 368.65 369.15
14-Mar-2012 373.25 387.15
15-Mar-2012 387 375.2
16-Mar-2012 375.45 367.45
19-Mar-2012 369.85 362.3
20-Mar-2012 362.2 367.55
21-Mar-2012 365.2 377.05
22-Mar-2012 375.65 366.05
23-Mar-2012 368.35 373
26-Mar-2012 370.95 358.15
27-Mar-2012 362.5 355.15
28-Mar-2012 355 349.5
29-Mar-2012 346.25 361.55
30-Mar-2012 360.05 368.6
Source: www.nseindia.com




51






OBSERVATIONS AND FINDINGS:

If a person buys 1 lot i.e.1000 futures of YES BANK on 5-Mar-2012 and sell
on 30-Mar-2012 then he will get a profit of 368.6-341.45 =27.15 per share, so he will
get a profit of 27150 i.e.(27.15*1000). If he sells on 7-Mar-2012 then he will get a
loss of 340.5-341.45=-0.95 i.e. a loss of 0.95 per share, so his total loss is 950
i.e.(1000*0.95)
The closing price of YES BANK at the end of the contract period is 368.6 and this is
considered as settlement price.

330
340
350
360
370
380
390
2-Mar-12 7-Mar-12 12-Mar-12 17-Mar-12 22-Mar-12 27-Mar-12 1-Apr-12
YES BANK
MARKET PRICE FUTURE PRICE

52
OPTIONS

ANALYSIS OF HDFC:
The following table explains the market price and premiums of calls.
The first column explains trading date
Second column explains the SPOT market price in cash segment on that date.
The third column explains call premiums amounting at these strike prices;
500, 520, 560, 580, 600, 620..















53

Call options:
TABLE 4.1

Strike prices
Date Market
price
500 520 560 580 600 620
5-Mar-2012 671.2
28 15.8 4.75 2.5 1.55 0.15
6-Mar-2012 659.05
22.1 13.25 3.55 1.8 0.4 0.15
7-Mar-2012 652.7
28.65 17.4 5.05 2.55 0.4 0.15
9-Mar-2012 666.75
34.4 20.75 6.4 2.85 0.4 0.15
12-Mar-2012 688.6
29.55 17.7 4.55 2.05 1.3 0.15
13-Mar-2012 679.3
33.5 19.05 4.1 1.65 1.3 0.15
14-Mar-2012 691
31.4 20.85 4.85 2.05 1.3 0.15
15-Mar-2012 680.3
22.1 10.55 1.9 1.05 1.3 0.15
16-Mar-2012 668.95
17.5 8.15 1.2 1 1.3 0.15
19-Mar-2012 671
11 4.15 1 0.55 0.7 0.15
20-Mar-2012 658.5
13.65 5.3 0.6 0.55 0.7 0.15
21-Mar-2012 660.7
22.4 9.2 0.8 0.5 0.15 0.15
22-Mar-2012 669.4
11.3 3.8 1 0.25 0.15 0.15
23-Mar-2012 664
16.35 5.2 0.2 0.25 0.1 0.15
26-Mar-2012 658.95
14.05 3.65 0.2 0.15 0.05 0.15
27-Mar-2012 657.55
18.2 5.8 0.2 0.1 0.05 0.15
28-Mar-2012 664.65
14 1.5 0.05 0.1 0.05 0.15
29-Mar-2012 655.85
10 0.1 0.05 0.05 0.05 0.15
30-Mar-2012 678.6
30.45 18.45 4.2 1.8 2.3 0.05
Source: ww.nseindia.com

54

OBSERVATIONS AND FINDINGS

CALL OPTION

BUYERS PAY OFF:
Those who have purchase call option at a strike price of 600, the premium
payable is 1.55.
On the expiry date the spot market price enclosed at 678.6 As it is out of the
money for the buyer and in the money for the seller, hence the buyer is in loss.
So the buyer will lose only premium i.e. 1.55 per share.
So the total loss will be 775 i.e.500*1.55.

SELLERS PAY OFF:
As Seller is entitled only for premium if he is in profit.
So his profit is only premium i.e. 500*1.55=775







55
Put options:
TABLE 4.2
Source: www.nseidia.com

Strike prices
Date Market price 500 520 560 580 600 620
5-Mar-2012 671.2
11.8 20.75 41 140.05 158.45 177.15
6-Mar-2012 659.05
13.85 22.2 41 140.05 158.45 177.15
7-Mar-2012 652.7
9.4 17 41 140.05 158.45 177.15
9-Mar-2012 666.75
6.4 13.3 41 140.05 158.45 177.15
12-Mar-2012 688.6
6.65 13.95 41 140.05 158.45 177.15
13-Mar-2012 679.3
4.35 9.95 41 140.05 158.45 177.15
14-Mar-2012 691
3.25 7.95 41 140.05 158.45 177.15
15-Mar-2012 680.3
6.8 15.45 41 140.05 158.45 177.15
16-Mar-2012 668.95
7.15 16.45 41 140.05 158.45 177.15
19-Mar-2012 671
11.2 22.85 41 140.05 158.45 177.15
20-Mar-2012 658.5
6.6 18.15 41 140.05 158.45 177.15
21-Mar-2012 660.7
3.25 10.05 41 140.05 158.45 177.15
22-Mar-2012 669.4
6.9 18.4 41 140.05 158.45 177.15
23-Mar-2012 664
3.6 11.35 41 140.05 158.45 177.15
26-Mar-2012 658.95
3 13 41 140.05 158.45 177.15
27-Mar-2012 657.55
1.2 5 41 140.05 158.45 177.15
28-Mar-2012 664.65
1.3 8.85 47 140.05 158.45 177.15
29-Mar-2012 655.85
0.05 2.75 47 140.05 158.45 177.15
30-Mar-2012 678.6
6.45 13 67.3 83.2 100.2 117.95

56
OBSERVATIONS AND FINDINGS
PUT OPTION
BUYERS PAY OFF:
As brought 1 lot of HDFC Bank that is 500, those who buy for 600 paid
158.45 premium per share.
Settlement price is 678.6
Strike price 600.00
Spot price 678.60
-78.6
Premium (-) 158.45
-79.85*500= -39925
Buyer loss = Rs. -39925
Because it is negative it is out of the money contract hence buyer will get loss, incase
spot price increases, buyers loss will increase.

SELLERS PAY OFF:
It is out of the money for the buyer so it is in the money for the seller, hence
he is in profit.
The profit is equal to the loss of buyer i.e. 39925.00.



57


ANALYSIS OF AXIS BANK:
The following table explains the market price and premiums of calls.
The first column explains trading date
Second column explains the SPOT market price in cash segment on that date.
The third column explains call premiums amounting at these strike prices;
820, 840, 860, 880, 900, 920.














58

Call options:
TABLE 4.3
Strike prices
Date Market
price
820 840 860 880 900 920
5-Mar-2012 1168.8 90.15 81.2 72.95 65.35 250 52.15
6-Mar-2012 1147.1 90.15 81.2 72.95 65.35 250 52.15
7-Mar-2012 1142.15 90.15 81.2 72.95 65.35 250 52.15
9-Mar-2012 1191 90.15 81.2 72.95 65.35 250 52.15
12-Mar-2012 1236.5 90.15 81.2 72.95 65.35 250 52.15
13-Mar-2012 1222 90.15 81.2 72.95 65.35 250 52.15
14-Mar-2012 1257.9 90.15 81.2 72.95 65.35 250 52.15
15-Mar-2012 1274.6 90.15 81.2 72.95 65.35 250 52.15
16-Mar-2012 1243 90.15 81.2 72.95 65.35 250 52.15
19-Mar-2012 1228.9 90.15 81.2 72.95 65.35 250 52.15
20-Mar-2012 1207.2 90.15 81.2 72.95 65.35 250 52.15
21-Mar-2012 1188.5 90.15 81.2 72.95 65.35 250 52.15
22-Mar-2012 1239.8 90.15 81.2 72.95 65.35 275 52.15
23-Mar-2012 1184 90.15 81.2 72.95 65.35 275 52.15
26-Mar-2012 1176.55 90.15 81.2 72.95 65.35 275 52.15
27-Mar-2012 1150.35 90.15 81.2 72.95 65.35 275 52.15
28-Mar-2012 1130.8 90.15 81.2 72.95 65.35 275 52.15
29-Mar-2012 1104.95 90.15 81.2 72.95 65.35 275 52.15
30-Mar-2012 1129.65 90.15 81.2 72.95 65.35 0 52.15
Source: www.nseindia.com

59

OBSERVATIONS AND FINDINGS
CALL OPTION

BUYERS PAY OFF:
Those who have purchase call option at a strike price of 920, the premium
payable is 52.15.
On the expiry date the spot market price enclosed at 1129.65. As it is In of the
money for the buyer and Out of the money for the seller, hence the buyer is in
profit.
So the buyer will get profit by MP-SP i.e. 1129.65-920=209.65 per share.
So the total profit will be 52412.5 i.e. 209.65*250.

SELLERS PAY OFF:
As Seller is entitled for loss.
So his loss is 52412.5 i.e. 209.65*250.






60

Put options:
TABLE 4.4
Strike prices
Date Market price 820 840 860 880 900 920
5-Mar-2012 1168.8 74.7 85.25 96.5 108.45 5 3
6-Mar-2012 1147.1 74.7 85.25 96.5 108.45 5 3
7-Mar-2012 1142.15 74.7 85.25 96.5 108.45 5 3
9-Mar-2012 1191 74.7 85.25 96.5 108.45 5 3
12-Mar-2012 1236.5 74.7 85.25 96.5 108.45 5 3
13-Mar-2012 1222 74.7 85.25 96.5 108.45 5 3
14-Mar-2012 1257.9 74.7 85.25 96.5 108.45 1 3
15-Mar-2012 1274.6 74.7 85.25 96.5 108.45 1 3
16-Mar-2012 1243 74.7 85.25 96.5 108.45 1 3
19-Mar-2012 1228.9 74.7 85.25 96.5 108.45 1 3
20-Mar-2012 1207.2 74.7 85.25 96.5 108.45 1 3
21-Mar-2012 1188.5 74.7 85.25 96.5 108.45 1 3
22-Mar-2012 1239.8 74.7 85.25 96.5 108.45 1 3
23-Mar-2012 1184 74.7 85.25 96.5 108.45 1 3
26-Mar-2012 1176.55 74.7 85.25 96.5 108.45 1 3
27-Mar-2012 1150.35 74.7 85.25 96.5 108.45 1 3
28-Mar-2012 1130.8 74.7 85.25 96.5 108.45 1 3
29-Mar-2012 1104.95 74.7 85.25 96.5 108.45 0.25 3
30-Mar-2012 1129.65 74.7 85.25 96.5 108.45 5 3
Source: www.nseindia.com

61

OBSERVATIONS AND FINDINGS
Put options:
BUYERS PAY OFF:
As brought 1 lot of AXIS Bank that is 250, those who buy for 920 paid 3
premium per share.
Settlement price is 922.75
Strike price 920.00
Spot price 1129.65
-209.65
Premium (-) 3
-206.65 x 250= -51662.5
Buyer loss = Rs. -51662.5
Because it is negative it is out of the money contract hence buyer will get loss, incase
spot price increases, buyers loss will increase.

SELLERS PAY OFF:
It is out of the money for the buyer so it is in the money for the seller, hence
he is in profit.
The profit is equal to the loss of buyer i.e. -51662.5


62


ANALYSIS OF YES BANK:
The following table explains the market price and premiums of calls.
The first column explains trading date
Second column explains the SPOT market price in cash segment on that date.
The third column explains call premiums amounting at these strike prices;
180, 200, 220, 240, 260.















63

Call option

TABLE 4.5
Strike prices
Date Market
price
180 200 220 240 260
5-Mar-2012 350.05
66.45 50.65 37.2 26.45 18.25
6-Mar-2012 338.6
66.45 50.65 37.2 26.45 18.25
7-Mar-2012 340.3
66.45 50.65 37.2 26.45 18.25
9-Mar-2012 345.4
66.45 50.65 37.2 26.45 18.25
12-Mar-2012 371.5
66.45 50.65 37.2 26.45 18.25
13-Mar-2012 368.65
66.45 50.65 37.2 26.45 18.25
14-Mar-2012 373.25
66.45 50.65 37.2 26.45 18.25
15-Mar-2012 387
66.45 50.65 37.2 26.45 18.25
16-Mar-2012 375.45
66.45 50.65 37.2 26.45 18.25
19-Mar-2012 369.85
66.45 50.65 37.2 26.45 18.25
20-Mar-2012 362.2
66.45 50.65 37.2 26.45 18.25
21-Mar-2012 365.2
66.45 50.65 37.2 26.45 18.25
22-Mar-2012 375.65
66.45 50.65 37.2 26.45 18.25
23-Mar-2012 368.35
66.45 50.65 37.2 26.45 18.25
26-Mar-2012 370.95
66.45 50.65 37.2 26.45 18.25
27-Mar-2012 362.5
66.45 50.65 37.2 26.45 18.25
28-Mar-2012 355
66.45 50.65 37.2 26.45 18.25
29-Mar-2012 346.25
66.45 50.65 37.2 26.45 18.25
30-Mar-2012 360.05
66.45 50.65 37.2 26.45 18.25
Source: www.nseindia.com

64

OBSERVATIONS AND FINDINGS
CALL OPTION

BUYERS PAY OFF:
Those who have purchase call option at a strike price of 240, the premium
payable is 26.45.
On the expiry date the spot market price enclosed at 360.05. As it is out of the
money for the buyer and in the money for the seller, hence the buyer is in loss.
So the buyer will lose only premium i.e. 26.45 per share.
So the total loss will be 26450 i.e.26.45*1000

SELLERS PAY OFF:
As Seller is entitled only for premium if he is in profit.
So his profit is only premium i.e. 26.45*1000








65

Put option:
TABLE 4.6
Strike prices
Date Market
price
180 200 220 240 260
5-Mar-2012 350.05
2.75 6.45 12.55 21.35 19.45
6-Mar-2012 338.6
2.75 6.45 12.55 21.35 19.45
7-Mar-2012 340.3
2.75 6.45 12.55 21.35 19.45
9-Mar-2012 345.4
2.75 6.45 12.55 21.35 19.45
12-Mar-2012 371.5
2.75 6.45 12.55 21.35 19.45
13-Mar-2012 368.65
2.75 6.45 12.55 21.35 19.45
14-Mar-2012 373.25
2.75 6.45 12.55 21.35 19.45
15-Mar-2012 387
2.75 6.45 12.55 21.35 19.45
16-Mar-2012 375.45
2.75 6.45 12.55 21.35 19.45
19-Mar-2012 369.85
2.75 6.45 12.55 21.35 19.45
20-Mar-2012 362.2
2.75 6.45 12.55 21.35 19.45
21-Mar-2012 365.2
2.75 6.45 12.55 21.35 19.45
22-Mar-2012 375.65
2.75 6.45 12.55 21.35 19.45
23-Mar-2012 368.35
2.75 6.45 12.55 21.35 19.45
26-Mar-2012 370.95
2.75 6.45 12.55 21.35 19.45
27-Mar-2012 362.5
2.75 6.45 12.55 21.35 19.45
28-Mar-2012 355
2.75 6.45 12.55 21.35 19.45
29-Mar-2012 346.25
2.75 6.45 12.55 21.35 19.45
30-Mar-2012 360.05
2.75 6.45 12.55 21.35 19.45
Source: www.nseindia.com


66

OBSERVATIONS AND FINDINGS
PUT OPTION
BUYERS PAY OFF:
As brought 1 lot of YES Bank that is 1000, those who buy for 240 paid 21.35
premium per share.
Settlement price is 360.05
Strike price 240.00
Spot price 360.05
-120.50
Premium (-) 21.35
-98.7*1000 = -98700
Buyer loss = Rs. -98700
Because it is negative it is out of the money contract hence buyer will get
loss, incase spot price increases, buyers loss will increase.

SELLERS PAY OFF:
It is out of the money for the buyer so it is in the money for the seller, hence
he is in profit.
The profit is equal to the loss of buyer i.e. -98700.

67


ANALYSIS OF ICICI:
The following table explains the market price and premiums of calls.
The first column explains trading date
Second column explains the SPOT market price in cash segment on that date.
The third column explains call premiums amounting at these strike prices;
600, 620, 640, 660, 700.














68

Call options:
Table 4.7
Strike prices
Date Market price 600 620 640 660 700
5-Mar-2012 905
131.6 118.95 107.25 96.35 77.15
6-Mar-2012 874.4
131.6 118.95 107.25 96.35 77.15
7-Mar-2012 856.35
131.6 118.95 107.25 96.35 77.15
9-Mar-2012 884.65
131.6 118.95 107.25 96.35 77.15
12-Mar-2012 937.55
131.6 118.95 107.25 96.35 77.15
13-Mar-2012 939.6
131.6 118.95 107.25 96.35 77.15
14-Mar-2012 951.15
131.6 118.95 107.25 96.35 77.15
15-Mar-2012 960
131.6 118.95 107.25 96.35 77.15
16-Mar-2012 942
131.6 118.95 107.25 96.35 77.15
19-Mar-2012 932.5
131.6 118.95 107.25 96.35 77.15
20-Mar-2012 912.8
131.6 118.95 107.25 96.35 77.15
21-Mar-2012 908.75
131.6 118.95 107.25 96.35 77.15
22-Mar-2012 943.3
131.6 118.95 107.25 96.35 77.15
23-Mar-2012 910
131.6 118.95 107.25 96.35 77.15
26-Mar-2012 907
131.6 118.95 107.25 96.35 77.15
27-Mar-2012 889.1
131.6 118.95 107.25 96.35 77.15
28-Mar-2012 877.15
131.6 118.95 107.25 96.35 77.15
29-Mar-2012 852.75
131.6 118.95 107.25 96.35 77.15
30-Mar-2012 867.25
131.6 118.95 107.25 96.35 77.15
Source: www.nseindia.com


69

OBSERVATIONS AND FINDINGS
CALL OPTION

BUYERS PAY OFF:
Those who have purchase call option at a strike price of 700, the premium
payable is 77.15.
On the expiry date the spot market price enclosed at 867.25. As it is Out of the
money for the buyer and In the money for the seller, hence the buyer is in loss.
So the buyer will lose only premium i.e. 77.15 per share.
o So the total loss will be 19287.5 i.e. 250 * 77.15

SELLERS PAY OFF:
As Seller is entitled only for premium if he is in profit.
So his profit is only premium i.e. 77.15*250=19287.5.








70

Put options:
Table 4.8
Strike prices
Date Market price 600 620 640 660 700
5-Mar-2012 905
31.05 37.95 45.75 54.4 3
6-Mar-2012 874.4
31.05 37.95 45.75 54.4 3
7-Mar-2012 856.35
31.05 37.95 45.75 54.4 3
9-Mar-2012 884.65
31.05 37.95 45.75 2 3
12-Mar-2012 937.55
31.05 37.95 45.75 2 3
13-Mar-2012 939.6
31.05 37.95 45.75 2 3
14-Mar-2012 951.15
31.05 37.95 45.75 2 3
15-Mar-2012 960
31.05 37.95 45.75 2 3
16-Mar-2012 942
31.05 37.95 45.75 2 3
19-Mar-2012 932.5
31.05 37.95 45.75 2 0.5
20-Mar-2012 912.8
31.05 37.95 45.75 2 0.5
21-Mar-2012 908.75
31.05 37.95 45.75 2 0.5
22-Mar-2012 943.3
31.05 37.95 45.75 2 0.5
23-Mar-2012 910
31.05 37.95 45.75 2 0.5
26-Mar-2012 907
31.05 37.95 45.75 2 0.5
27-Mar-2012 889.1
31.05 37.95 45.75 2 0.5
28-Mar-2012 877.15
31.05 37.95 45.75 2 0.5
29-Mar-2012 852.75
31.05 37.95 45.75 2 0.5
30-Mar-2012 867.25
31.05 37.95 45.75 2 0.5
Source: www.nseindia.com


71

OBSERVATIONS AND FINDINGS
PUT OPTION:
BUYERS PAY OFF:
As brought 1 lot of ICICI Bank that is 350, those who buy for 700 paid 3
premium per share.
Settlement price is 867.25
Strike price 700.00
Spot price 867.25
-167.25
Premium (-) 3
-164.25 * 250= -41062.5
Buyer loss = Rs. -41062.5
Because it is negative it is Out of the money contract hence buyer will get more loss,
incase spot price increases, buyers loss will increase.

SELLERS PAY OFF:
It is Out of the money for the buyer so it is, In the money for the seller, hence
he is in profit.
The profit is equal to the loss of buyer i.e. -41062.5

72




SUGGESTIONS:

In order to increase the market in India, SEBI should revise some of their
regulations like contract size, participation of FII in the derivatives market.
Contract size should be minimized because small investors cannot afford this
much of huge premiums.
SEBI has to take further steps in the risk management mechanism.
SEBI has to take measures to use effectively the derivatives segment as a tool
of hedging.












73




CONCLUSION:

The market in India has been expanding rapidly and will continue to
grow. While much of the activity is concentrated in foreign and a few private sector
banks, increasingly public sector banks are also participating in this market as market
makers and not just users. Their participation is dependent on development of skills,
adapting technology and developing sound risk management practices are very useful
for hedging and risk transfer, and hence improve market efficiency, it is necessary to
keep in view the risks of excessive leverage, lack of transparency particularly in
complex products, difficulties in valuation, tail risk exposures, counterparty exposure
and hidden systemic risk. Clearly there is need for greater transparency to capture the
market, credit as well as liquidity risks in off-balance sheet positions and providing
capital therefor. From the corporate point of view, understanding the product and
inherent risks over the life of the product is extremely important.
Further development of the market will also hinge on adoption of
international accounting standards and disclosure practices by all market participants.






74



BIBILOGAPHY

BOOKS:
1. Options Futures, and other by John C Hull
2. Financial Institutions Markets & Services FAQ by Ajay Shah
3. NSEs Certification in Financial Markets: - Derivatives Core module
4. Investment Monitor Magazine

Reports
1. Regulatory framework for financial Markets in India by Dr. L.C.Gupta
2. Risk containment in the markets by Prof.J.R.Verma

Financial news papers:
Economic times &
Business Standard.










75



WEBSITES:
www.nseindia.com
http://www,nseindia/ontent.fofo_historical data.htm
http://www.derivativesindia/scripts/glossary/indexobasic.asp
http://www.bseindia/about/derivatives.asp#tyepsofpod.htm
http://business.mapsofindia.com/investment-industry/indian-derivatives-
market.html
www.derivativesindia.com
www.sebi.gov.in
www.rediff/money/derivatives.htm
www.igidr.ac.in/~ajayshah
www.iinvestor.com
www.appliederivatives.com
www.derivativesreview.com
www.economictimes.com