WEEK 2 TASK

PROJECT NAME -STUDY OF DERIVATIVES

OF BOMBAY STOCK EXCHANGE (BSE) AND
NATIONAL STOCK EXCHANGE (NSE)

STUDENT NAME- SHIVANG PAL

UNIVERSITY ROLL NO. –2212042020042

INTERN ID – VL/SIT/FM/14
 INTRODUCTION TO DERIVATIVES

The term derivative refers to a type of financial contract whose value

isdependent on an underlying assets group of assets, or benchmark.
Aderivative is set between two or more parties that can trade on
anexchange or over the counter (OTC)

A derivative is a complex type of financial security that is set

betweentwo or more parties. Derivatives can take many forms, from
stock andbond derivatives to economic indicator derivatives.

These could be stocks, indices, commodities, currencies, exchange

rates, or the rate of interest. These financial instruments help you make
profits by betting on the future value of the underlying asset. So, their
value is derived from that of the underlying asset. This is why they are
called ‘Derivatives’.

The value of the underlying assets changes every now and then; For
example, a stock’s value may rise or fall, the exchange rate of a pair of
currencies may change, indices may fluctuate, and commodity prices
may increase or decrease. These changes can help an investor make
profits. They can also cause losses. This is where derivatives come in
handy. It could help you make additional profits by correctly guessing
the future price, or it could act as a safety net from losses in the spot
market, where the underlying assets are traded.
 WHAT IS DERIVATIVE TRADING ?

A derivative is a formal financial contract allowing the investor to buy

orsell an asset for future periods. A fixed and predetermined expiry date
isset for a derivative contract. Trading derivatives on the stock market
isbetter than buying the underlying asset since the gains can be
significantlyexaggerated. In addition, derivative trading is a leveraged
form of trading,meaning you can buy a large amount of underlying
assets by paying asmall amount. Different derivatives, such as stocks,
commodities,
currencies, benchmarks, and so on, can be traded. There are two types
ofderivative contracts: futures and options. Since both the seller and
theinvestor forecast the underlying asset's price for a particular future
date,they are essentially the same. However, futures and options are
differentbecause, in futures, there is a legal obligation on both buyers
and sellers tohonor the contract's expiration.

In the case of options, however, the buyer or the seller may buy and
sellbefore the expiry of the contract by exercising their rights or by
letting thecontract expire without exercising their rights. The two types
of options arethe Call option and the Put option. Investors are confident
that the
underlying asset will increase by a call option. On the other hand,
whenthey feel satisfied that the price of their underlying asset will fall,
theypurchase a Put option.
 Use of Derivatives

In the Indian markets, futures and options are standardized contracts, which
can be freely traded on exchanges. These could be employed to meet a variety
of needs.

Earn money on shares that are lying idle

So you don’t want to sell the shares you bought for the long term but want to

take advantage of price fluctuations in the short term. You can use derivative
instruments to do so. The derivatives market allows you to conduct
transactions without selling your shares - also called physical settlement.

Benefit from arbitrage

Arbitrage trading is when you buy low in one market and sell high in another.
Simply put, you are taking advantage of price differences in the two markets.

Protect your securities

Protect your securities against fluctuations in prices. The derivative market

offers products that allow you to hedge against a fall in the price of shares that
you possess. It also provides products that protect you from a rise in the price
of shares that you plan to purchase. This is called hedging.

Transfer of risk

By far, the most critical use of these derivatives is the transfer of market risk
from risk-averse investors to those with a risk appetite. Risk-averse investors
use derivatives to enhance safety while risk-loving investors like speculators
conduct risky, contrarian trades to improve profits. This way, the risk is
transferred.
 TYPES OF DERIVATIVE CONTRACTS :-

Four types of derivative contracts exist: forwards, futures, options,

and swaps.

Futures and forwards: Futures are contracts that represent an

agreement to buy or sell a set of assets at a specified time in the future
for a specified amount. Forwards are futures that are not standardized.
They are not traded on a stock exchange.

Options :These contracts are quite similar to futures and forwards.

However, there is one key difference. Once you buy an options
contract, you are not obligated to hold the terms of the agreement.

Swaps: Swaps are the financial instruments that allow two parties to
swap or exchange their financial obligations and liabilities. Both parties
determine the cash flow in the contract based on a rate of interest.
One cash flow is usually fixed in this contract, while the second varies
according to a benchmark interest rate.

Forward: A forward contract is a financial contract between two

parties based on a predetermined amount and the price of the
underlying securities to be executed before the expiry date. Like futures,
forward contracts bind both parties to take delivery of the contract
before expiry. However,
investors can only trade such contracts through an Over the Counter
market rather than a supervised stock market exchange.
 ADVANTAGES OF DERIVATIVES

The benefits of derivatives are as follows:-

1.Low Expenses The charges are low compared to the shares

or debentures, given that derivative trading is mainly a risk
reduction exercise.

2.Transfer Risks Derivatives allow you to spread risks between

all participants instead of stock market trading. Therefore,
your risk is reduced to a great extent.

3.Hedge Risks You can hedge your position in the cash market
by trading derivatives. For example, you can buy a Put option
on the derivative market if you buy positional stocks in cash
markets. The value of your Put option will increase when the
stock falls on the cash market. Therefore, your losses will be
minimal or nil.
 DISADVANTAGES OF DERIVATIVES

Derivatives trading may offer several advantages for hedging or

increasing profits when invested with prior knowledge and extensive
research. However, such financial instruments are complex and have
certain disadvantages for market participants.

1.Counterparty risk: Although market participants can trade futures

contracts through supervised exchanges, they can also trade
options contracts over the counter. With the possibility of the
other party defaulting on the payment or exercise of the promise,
there needs to be an established due diligence system.
Consequently, market participants may incur financial loss due to
counterparty risk.

2.High risk These instruments are market-linked, and their value is

derived from the change in the price of an asset using real-time.
These prices are influenced by demand and supply factors, which
can be volatile. As a result of the volatility, these financial
contracts are exposed to risk, which could lead to significant
losses for the undertakings.

3.Speculation: A system of assumptions is used for most parts of the

derivatives market. Entities speculate on the possible price
direction of an asset and hope to make money from a difference
between strike prices and execution prices. However, entities may
suffer losses if speculation moves in the opposite direction.
 TYPES OF MARKET PARTICIPANTS

Participants in the derivatives market can be classified into 4 categories

based on their trading motives :-
1)Speculators :

Speculators bear the risk in the market. They embrace risk to earn a
profit. They have an opposite point of view as compared to the
hedgers. This opinion difference helps them make huge profits if the
bets turn correct. Let's say that you bought a put option to secure
yourself from a fall in stock prices. Your counterparty, i.e. the
speculator, will have to bet that the stock price won't fall. If it is so,
then you won't exercise your put option. Therefore, the speculator
keeps the premium and makes a profit.
2) Hedger:

Hedgers are risk-averse traders in the stock markets. They aim at

derivative markets to secure their investment portfolio against market
risk and price fluctuations. They do this by assuming the exact opposite
position in the derivatives market. In this manner, they transfer the risk
to those ready to take it. However, they have to pay a premium to the
risk-taker for the hedging available.

3) Margin Traders:

Margin means the minimum amount you need to deposit with the
broker to participate in the derivative market. It is used to reflect losses
and gains daily based on market movements. It gives leverage in the
derivative market and maintains a large outstanding position.
4) Arbitrageurs:

These use low-risk market imperfections to gain profits. They usually

buy low-priced securities simultaneously in one market and sell them at
a higher price in another market. However, this can only happen when
the same security is quoted at different prices in different markets.
 COMPARISON BETWEEN BSE AND
NSE
DERIVATIVE MARKETS

The National Stock Exchange (NSE) and the Bombay Stock Exchange
(BSE) are two of the major stock exchanges in India. Both offer
derivative markets, but there are some differences between them:-

1. Market Structure and Liquidity:

NSE: The NSE is known for having higher liquidity and trading
volume compared to the BSE. Its derivative market is particularly
active, especially for index futures and options. The NSE
introduced the concept of electronic trading in India and has a
reputation for high-frequency trading.

BSE: The BSE also offers derivative products but generally has lower
liquidity compared to the NSE. The BSE is known for having a
more traditional trading environment, although it has
modernized its operations over time.
2. Types of Derivative Products:

NSE:The NSE’s derivative market includes a broad range of

products such as index futures, index options, stock futures, and
stock options. The NSE is known for its popular Nifty 50 index
derivatives.

BSE:The BSE also offers similar derivative products including index

futures, index options, stock futures, and stock options. The BSE’s
benchmark index for derivatives is the Sensex.
3. Contract Specifications:

NSE: The NSE often leads in introducing new contract



specifications and products in the derivatives space. For example,

NSE was among the first to introduce long-term options and
various indices for derivatives.
BSE:
While the BSE offers competitive contract specifications, it may
sometimes follow the NSE's lead in introducing new products.
4. Trading Platforms and Technology:

NSE: The NSE uses a highly advanced electronic trading system, which
facilitates faster and more efficient trading. Its technology infrastructure is
known for its robustness.

BSE: The BSE has also upgraded its trading systems to be more competitive,
but historically, NSE has been seen as more technologically advanced.
5. Market Share and Popularity:

NSE: The NSE generally has a larger market share in terms of trading
volumes and open interest in derivatives. It is the preferred exchange for
many institutional and retail traders due to its liquidity.

BSE:The BSE’s market share in derivatives is comparatively smaller, but it

remains a significant player in the Indian financial markets.
6. Regulatory Oversight:

Both exchanges are regulated by the Securities and Exchange Board of India
(SEBI), which ensures that they adhere to similar regulatory standards.
However, the exchanges may have different rules and practices regarding
trading and settlement.

Overall, while both NSE and BSE offer derivative products, the NSE is typically
seen as the more dominant player in this segment due to its higher liquidity and
more advanced trading technology.
 RISK ASSOCIATED WITH DERIVATIVE
MARKETING
Derivative marketing, which often involves the use of financial derivatives or
leveraging marketing strategies tied to derivatives, can come with several types of
risks:

1.Market Risk: This is the risk that the underlying asset or market condition
linked to the derivative will move unfavorably. For example, if a marketing
campaign is tied to the performance of a stock or commodity, any adverse
movements in that asset can negatively impact the campaign’s
effectiveness and profitability.

2.Credit Risk: If the marketing strategy involves counterparties (e.g., financial

institutions or partners), there’s a risk that these parties might fail to meet
their obligations. This could disrupt marketing activities or result in financial
losses.

3.Operational Risk: This includes risks related to the execution of marketing

strategies. For instance, if there are errors in the implementation or
management of derivative-based marketing strategies, it could lead to
significant losses or inefficiencies.

4.Regulatory Risk: Derivatives are subject to various regulations and

compliance requirements. Changes in regulations or failure to adhere to
them can result in legal issues, fines, or other penalties that can impact
marketing efforts.
5.Liquidity Risk: If derivatives are not easily tradable or if there’s insufficient
market liquidity, it may be challenging to execute trades or exit positions,
potentially leading to unfavorable outcomes for the marketing strategy.

6.Reputation Risk: If the derivative-based marketing strategy fails or leads to

significant losses, it can damage the reputation of the company, impacting
customer trust and brand value.

7.Model Risk: If the marketing strategy relies on complex financial models or

predictions related to derivatives, there’s a risk that these models may be
flawed or based on incorrect assumptions, leading to poor decision-making.
 PROCESS OF TRADING DERIVATIVES
ON NSE AND BSE

Trading derivatives on the NSE (National Stock Exchange) and BSE (Bombay Stock
Exchange) in India involves several steps. Here’s a detailed process for trading
derivatives on these exchanges:
1. Open a Trading Account:
Select a Broker: Choose a SEBI (Securities and Exchange Board of India)
registered broker who offers derivatives trading.

Complete KYC: Submit KYC (Know Your Customer) documents like identity
proof, address proof, and a recent photograph.

Tradingand Demat Accounts: Open a trading account (for buying/selling)

and a demat account (for holding securities).

2. Get Derivatives Approval:

Derivatives Trading Approval: Ensure your trading account is enabled for

derivatives trading, which might require additional documentation and

approval from the broker.

3. Fund Your Account:

Deposit Funds: Transfer money into your trading account to meet margin

requirements and facilitate trades.

4. Understand Margin Requirements:

Initial Margin: The amount required to open a futures or options position.
Maintenance Margin: The minimum amount that must be maintained in
the margin account to keep the position open.
5. Trading Platform:
Use Trading Software: Access the trading platform provided by your

broker. This software allows you to place trades, view real-time data, and
monitor positions.

6. Placing Orders:
Futures Trading: Decide on the contract size, expiry date, and order type

(market or limit order).

Options Trading: Choose the type of option (call or put), strike price, expiry
date, and order type.

7. Monitor Positions:
Track Performance: Keep an eye on market movements and the

performance of your positions.

AdjustPositions: You may need to adjust or close positions based on

market conditions.

8. Settlement and Expiry:

Expiry of Futures/Options: Futures and options contracts have a fixed

expiry date. Positions need to be squared off or rolled over before expiry.

Settlement: Futures contracts are settled on the expiry date, either by

physical delivery or cash settlement. Options are settled by exercising the
option or by closing the position.

9. Risk Management:
Stop-Loss Orders: Set stop-loss orders to limit potential losses.

Hedging: Use derivatives to hedge against other investments or positions.

10. Compliance and Reporting:

Taxation: Derivative trading has specific tax implications. Keep records of

all trades and consult a tax professional if needed.

 Regulatory Reporting: Ensure compliance with SEBI regulations and report any
necessary details to authorities.
11. Education and Strategy:

Continuous Learning: Keep educating yourself about market trends, trading

strategies, and derivative instruments.

Develop Strategies: Build and refine trading strategies based on market

research and personal experience.
 CONCLUSION

Derivatives, including futures and options, are complex financial

instruments that derive their value from underlying assets like stocks,
indices, or commodities. They offer traders and investors tools for
speculation, hedging, and managing risk. Futures contracts commit to
buying or selling an asset at a future date for a predetermined price,
while options provide the right, but not the obligation, to do so.

Trading derivatives involves understanding margin requirements,

leveraging, and potential risks such as market volatility. These
instruments can amplify both profits and losses, making effective risk
management crucial. Derivatives trading on exchanges like the NSE and
BSE requires a robust trading strategy, knowledge of market trends, and
compliance with regulatory norms.

While derivatives can enhance portfolio diversification and provide

strategic opportunities, they also necessitate thorough education and
prudent decision-making. For those well-versed in their mechanics and
implications, derivatives can be valuable tools in achieving financial
goals and navigating market uncertainties. However, their complexity
demands a disciplined approach and continuous learning to mitigate
risks and capitalize on their potential benefits.