INTERNSHIP PROJECT

ON
FUNDAMENTAL AND TECHNICAL
ANALYSIS ON EQUITY DERIVATIVES
A project report submitted in partial fulfilment of the
Requirements for the award of the degree of
MASTER OF BUSINESS ADMINISTRATION
By
N.TARUN KUMAR

(121723602037)

Under the esteemed guidance of

Prof P.ARUNA

GITAM INSTITUTE OF MANAGEMENT, GITAM (Deemed to be

University)

VISAKHAPATNAM
 CERTIFICATE

Certified that this is a bonafide record of project work entitled “FUNDAMENTAL AND
TECHNICAL ANALYSIS ON EQUITY DDERIVATIVES”, done in partial fulfilment for
the award of the degree of “Master of Business Administration”, GITAM Institute of
Management, GITAM(Deemed to be University) ,
Visakhapatnam.

P.ARUNA
Professor

GITAM Institute of Management

GITAM (Deemed to be University)

 DECLARATION

I hereby declare that the project entitled "“FUNDAMENTAL AND

TECHNICAL ANALYSIS ON EQUTIY DERIVATIVES”, done in partial fulfilment for the
award of the degree of “Master of Business Administration”, GITAM Institute of
Management, GITAM (Deemed to be University) ,
Visakhapatnam.

Signature of the Candidate

N.TARUN KUMAR
(121723602037)
 ACKNOWLEDGEMENT

The satisfaction that accompanies the successful completion of any task

would be incomplete without mentioning the people who made it possible and whose
constant guidance and encouragement crown all the efforts with success.

I would like to express my deep sense of gratitude and sincere thanks to

Prof P.ARUNA, GITAM Institute of Management for his consistent guidance,
supervision and motivation in completing the project.

I would also like to show my gratitude to Dr.P.Sheela, Principal, GITAM Institute of

Management, GITAM (Deemed to be University) ,Visakhapatnam

Finally it is a great pleasure to thank one and all that have helped directly
and indirectly throughout the project.

Signature of Candidate

N.TARUN KUMAR
(121723602037)
 INTRODUCTION
ABOUT THE COMPANY

J wings manifest wealth is a financial services and trading company which is mainly into stock market
and forex trading. They provide training services and various financial advisory services as well. J
wings is also into health Insurance and investment planning services .The company has vast
experience and comprehensive understanding in the field of forex trade and technical analysis. The
company offers trading through an online trading platform, under this online trading platform
investors are able to trade through various platforms such as web based terminal, mobile based
trading as well as app based trading. These online platforms enable the investors to trade in forex
market. They update the investors with the market trends and notify them on various fundamental
news regarding various currency pairs. Their office is situated at Horamavu, Bangalore, Karnataka

ABOUT THE PROJECT

OBJECTIVES.
o Understanding the concept of Indian Derivatives market
o To learn more about different derivative instruments and it’s functioning from
formation of the agreement till settlement with special focus on futures.
o To understand and examine the role of leverage and importance of margin account
in futures market
o To learn about the pay off structure and about the various risks and rewards related
to equity derivatives
To study the technical analysis and critically examine the working of futures in
derivatives market.

o To learn more about the candle stick charts and various technical indicators to analyse the
underlying assets.

RESEARCH METHODOLOGY

The study was under taken in the trading floor of kotak. The Information regarding
the derivatives is collected from both primary as well as secondary sources of data.

Primary data

 Watching the online trading live.

 Interacting with the operators at the computer terminal’s the clients trading in kotak
.
 Collecting information from the head of each department and from the staff working
in those departments.
 Secondary data

 Collecting the data from the website of NSE.

 Referring the topics in textbooks and journals relating to stock exchange operations.
 Collecting information through internet and also from KARVY STOCK BROKING
Limited.

2.3 LIMITATIONS

o Limited time period of three months

o Indian Derivatives is a very wide topic thus its unable to concentrate on all the
derivative instruments in this limited time period
o Many are not willing to invest in futures as they are highly leveraged products that
carries high risk
o Mostly investors are not willing/unable to invest large amounts and are risk averse o
Technical indicators may not be completely reliable all the time.
o People have less knowledge regarding derivatives market

FOREX MARKET
Forex market is also known as currency market , where 36 cross pair currencies are traded .The
major and mostly traded six currency pairs are AUS/USD,EUR/USD, GBP/USD,JPY/USD,
USD/CHF and XAU/USD(GOLD).The mostly traded currencies are dollar 84.9 % , Euro 39.1% and
Yen 19 %. One pip movement in currency is equivalent to 10 dollars , in gold one pip movement
is equivalent to 100 dollars and for silver its 50 dollars. Trading in forex is between various
currency pairs. The first currency in any currency pair is called base currency and the second
currency is called the quote currency. The difference in the ask and bid price gives the spread
amount , which goes to the broker as commission.

The bid price is actually the price at which the market is prepared to buy a specific currency pair
in the forex market .This is the price at which the trader sells the base currency. The ask price is
the price at which the market is prepared to sell a currency pair in the forex market .At this
price the trader buys the base currency.

For example ,if the quote for eur/usd has been given as bid 1.2815 and ask price as 1.2820 usd.

Here the trader can buy a euro for 1.2820 and can go for a short at 1.2815.
A standard lot is 100,000 units of the base currency, a mini lot represents 10,000 units ,a micro
lot represents 1000 units and a nano lot represents 100 units of the base currency. A pending
order allows the trader to set orders that will be activated once the price reaches a level chosen
by the trader. The most important four types of pending orders are buy limit,sell limit, sell stop
and buy stop. A buy limit order is executed when a buy order is placed below the current
market price. A buy stop order is entered at a stop price above the current market price. A sell
limit order is a sell pending order that is placed above the market price. A sell stop order is an
order to sell a stock if its price falls to a certain predetermined amount .

INDIAN DERIVATIVES

INDUSTRIAL PROFILE

INTRODUCTION TO FINANCIAL MARKETS

Finance is the integral part of modern business. Financial markets refer to the
institutional arrangements for dealing in financial assets and credit instruments of different
types, such as currency cheques, bank deposits bills, etc.

The main functions of the financial markets are:

(i) To facilitate creation and allocation of credit and liquidity

(ii) To serve as intermediaries for mobilization of savings;

(iii) To assist the process of balanced economic growth;

(iv) To provide financial convenience;

(v) To cater to the various credits needs of the business houses.

Types of Financial markets:

On the basis of the maturity period of the financial assets, the market can be divided into:

1. Money market:

A money market is a mechanism through which short-term funds are loaned and
borrowed and through which a large part of the financial transaction of a particular country of
the world are cleared.

The money market is divided into 3 sectors namely organized sector,

unorganized sector and Cooperative sector.

a. Organized sector is comparatively well developed in terms of organized

relationships and specialization of functions. It consists of the Reserve
Bank of India, various scheduled and non-scheduled commercial banks.
The development banks, other financial institutions like LIC, UTI,
discount and finance house of India limited are all a part of the organized
sector.

b. The unorganized sector is more dominate in India. The only link between
the organized and unorganized sectors is through commercial banks. It
consists of the indigenous bankers, Moneylenders, Nidhis and Chit funds.

c. The cooperative sector consists of the state –cooperative banks, primary

agricultural credit societies, Central Cooperative banks, and State Land
Development banks.
2. Capital market:

Capital market is an organized mechanism for effective and efficient transfer

of money capital of financial resources form the investing class i.e., a body of
individual or institutional savers, to the entrepreneur class i.e., a body of individual or
institutions engage in industry, business or service in the private and public sectors of
the economy.
Functions of capital market:

The capital market is directly responsible for the following activities.

 Mobilization of National savings for economic development

 Mobilization and import of foreign capital and foreign investment capital plus
skill to fill up the deficit in the required financial resources to maintain
expected rate of economic growth.
 Productive utilization of resources
 Direction the flow to funds of high yields and also strives for balance and
diversified industrialization.

Constituents of capital market:

The capital market comprises of mutual funds, development banks, specialized

financial institutions, investment institutions, state level development banks, lease companies,
financial service companies, commercial banks and other specialized institutions set up for
the growth of capital market like SEBI, CRISIL.

Instruments Capital market:

The following instruments are being used for raising resources.

Equity shares

Preference shares

Non-voting equity shares

Cumulative convertible preference shares company fixed deposits, banks, and

debentures, global depository receipts.

The capital market is divided into two parts namely new issues market and Stock
market.
STOCK EXCHANGES IN INDIA

At the end of the June 1989, there were 18 recognized stock exchanges in India. Among the

18 stock exchanges, the first organized stock exchange set up at Bombay in 1857 is

distinguished not only by its size but also it has been recognized permanently, while the

recognition for other markets is renewed every 5 years. Stock markets are organized either

as voluntary, non-profit making associations (Bombay, Ahmadabad, Indore) or public limited

companies (Calcutta, Delhi, Bangalore) or company limited by guarantee (Madras,

Hyderabad).

In India, the growth of stock exchanges has been linked to the growth of corporate
sector. Though a number of stock exchanges were set up before independence but, there
was no All India legislation to regulate they’re working. Every stock exchange followed its
own methods of working .To rectify this situation,

The SECURITY CONTRACTS (REGULATIONS) ACT was passed in 1956.

In 1965, 22 separate provincial stock exchanges were merged into 3 regional stock
exchanges and in 1973 these, in turn, were combined to form the National Stock Exchange
(NSE) under the title of the stock exchange that has trading floors in many former provincial
center. At present, there are 26 stock exchanges in our country. The over-the counter
exchange of India began its operations in 1992. Since 1995, trading in securities is screen
based (on-line)

BOMBAY STOCK EXCHANGE (BSE):

Bombay stock exchange is the first organized stock exchange set up at

Bombay in 1857. It is the premier or apex stock exchange in India as it is distinguished not
only by its size but also it has been recognized permanently while recognition of other stock
exchanges is renewed every 5 years. It is the oldest stock market.
 Bombay Stock Exchange raised the threshold limit for listing to Rs.10 crores,
moved on to weekly settlement and quicker actions for each settlement. Settlement is
through the clearinghouse. 12 days carry forward is allowed on BSE. Index in BSE is
‘SENSEX’. BSE membership fee in 1857 was just Rs1lakh and now it in about Rs 2crores.

NATIONAL STOCK EXCHANGE (NSE)

National Stock Exchange of India Ltd was started in 1992 with a paid-up
equity of Rs.25 crores. The government recognized it in the same year and NSE started its
operations in wholesale in Nov 1994.

NSE MISSION

NSE mission is setting the agenda for change in the securities markets in India.

The NSE was set-up with the main objectives of:

 establishing a nation-wide trading facility for equities, debt instruments and

hybrids,
 ensuring equal access to investors all over the country through an appropriate
communication network,
 providing a fair, efficient and transparent securities market to investors using
electronic trading systems,
 enabling shorter settlement cycles and book entry settlements systems, and
 meeting the current international standards of securities markets.
NSE LOGO

The logo of the NSE symbolizes a single nationwide securities trading facility
ensuring equal and fair access to investors, trading members and issuers all over the country.
The initials of the Exchange viz., N, S and E have been etched on the logo and are distinctly
visible. The logo symbolizes use of state of the art information technology and satellite
connectivity to bring about the change within the securities industry. The logo symbolizes
vibrancy and unleashing of creative energy to constantly bring about change through

innovation.

NSE MILE STONES

April 1993 November 1992 Incorporati

May 1993 Formulation of business plan

June 1994 Wholesale Debt Market segment goes live

November 1994 Capital Market (Equities) segment goes live

March 1995 Establishment of Investor Grievance Cell

April 1995 Establishment of NSCCL, the first Clearing Corporation

June 1995 Introduction of centralized insurance cover for all trading members

July 1995 Establishment of Investor Protection Fund

October 1995 Became largest stock exchange in the country

April 1996 Commencement of clearing and settlement by NSCCL

April 1996 Launch of S&P CNX Nifty

June 1996 Establishment of Settlement Guarantee Fund

Setting up of National Securities Depository Limited, first depository in

November 1996
India, co-promoted by NSE

November 1996 Best IT Usage award by Computer Society of India

December 1996 Commencement of trading/settlement in dematerialised securities

December 1996 Dataquest award for Top IT User

December 1996 Launch of CNX Nifty Junior

February 1997 Regional clearing facility goes live

November 1997 Best IT Usage award by Computer Society of India

Promotion of joint venture, India Index Services & Products Limited

May 1998
(IISL)

May 1998 Launch of NSE Web-site: www.nse.co.in

July 1998 Launch of NSE Certification Programme in Financial Market

August 1998 CYBER CORPORATE OF THE YEAR 1998 award

February 1999 Launch of Automated Lending and Borrowing Mechanism

April 1999 CHIP Web Award by CHIP magazine

October 1999 Setting up of NSE.IT

January 2000 Launch of NSE Research Initiative

February 2000 Commencement of Internet Trading

June 2000 Commencement of Derivatives Trading (Index Futures)

September 2000 Launch of 'Zero Coupon Yield Curve'

November 2000 Launch of Broker Plaza by Dotex International, a joint venture betw

December 2000 Commencement of WAP trading

June 2001 Commencement of trading in Index Options

July 2001 Commencement of trading in Options on Individual Securities

November 2001 Commencement of trading in Futures on Individual Securities

December 2001 Launch of NSE VaR for Government Securities

January 2002 Launch of Exchange Traded Funds (ETFs)

May 2002 NSE wins the Wharton-Infosys Business Transformation Award in t

October 2002 Launch of NSE Government Securities Index

January 2003 Commencement of trading in Retail Debt Market

June 2003 Launch of Interest Rate Futures

August 2003 Launch of Futures & options in CNXIT Index

June 2004 Launch of STP Interoperability

August 2004 Launch of NSE electronic interface for listed companies

March 2005 ‘India Innovation Award’ by EMPI Business School, New Delhi

June 2005 Launch of Futures & options in BANK Nifty Index

December 2006 'Derivative Exchange of the Year', by Asia Risk magazine

January 2007 Launch of NSE – CNBC TV 18 media center

March 2007 NSE, CRISIL announce launch of IndiaBondWatch.com

 June 2007 NSE launches derivatives on Nifty Junior & CNX 100

October 2007 NSE launches derivatives on Nifty Midcap 50

January 2008 Introduction of Mini Nifty derivative contracts on 1st January 2008

March 2008 Introduction of long term option contracts on S&P CNX Nifty Index

June2008 Launch of NCFM - Derivatives Market (Dealers) Module Test in Hin

September 2008
Launch of FEDAI-NSE Currency Futures (Basic) Module

Jan2009 Launch of Mutual Funds : A Beginners Module

Feb2009
Launch of NCFM - Capital Market (Dealers) Module Test in Gujarat

Feb2009 Launch of Shariah BeEs on Feb 4, 2009

Mar2009
Launch of "Options Trading Strategies Module"

NSE Technology

Across the globe, developments in information, communication and network

technologies have created paradigm shifts in the securities market operations. Technology
has enabled organizations to build new sources of competitive advantage, bring about
innovations in products and services, and to provide for new business opportunities. Stock
exchanges all over the world have realised the potential of IT and have moved over to
electronic trading systems, which are cheaper, have wider reach and provide a better
mechanism for trade and post trade execution.

NSE believes that technology will continue to provide the necessary impetus for the
organization to retain its competitive edge and ensure timeliness and satisfaction in
customer service. In recognition of the fact that technology will continue to redefine the
shape of the securities industry, NSE stresses on innovation and sustained investment in
technology to remain ahead of competition. NSE IT set-up is the largest by any company in
India. It uses satellite communication technology to energies participation from around 400
cities spread all over the country. In the recent past, capacity enhancement measures were
taken up in regard to the trading systems so as to effectively meet the requirements of
increased users and associated trading loads. With up gradation of trading hardware, NSE
can handle up to 1 million trades per day.

CIRCUIT BREAKERS
The Exchange has implemented index-based market-wide circuit breakers in
compulsory rolling settlement with effect from July 02, 2001

INDEX-BASED MARKET-WIDE CIRCUIT BREAKERS

The S & P CNX The index-based market-wide circuit breaker system applies at 3
stages of the index movement, either way viz. at 10%, 15% and 20%. These circuit breakers
when triggered bring about a coordinated trading halt in all equity and equity derivative
markets nationwide. The market-wide circuit breakers are triggered by movement of either
the BSE Sensex or the NSE S&P CNX Nifty, whichever is breached earlier.

 In case of a 10% movement of either of these indices, there would be a one-hour

market halt if the movement takes place before 1:00 p.m. In case the movement
takes place at or after 1:00 p.m. but before 2:30 p.m. there would be trading halt for
½ hour. In case movement takes place at or after 2:30 p.m. there will be no trading
halt at the 10% level and market shall continue trading.

 In case of a 15% movement of either index, there shall be a two-hour halt if the
movement takes place before 1 p.m. If the 15% trigger is reached on or after
1:00p.m. but before 2:00 p.m., there shall be a one-hour halt. If the 15% trigger is
reached on or after 2:00 p.m. the trading shall halt for remainder of the day.

 In case of a 20% movement of the index, trading shall be halted for the remainder of
the day.

S&PCNX NIFTY:

NIFTY is based upon solid economic research it the new world of financial product on
the index like index futures, index options and index funds. A trillions calculations were
expanded to evolve the rules inside the S&P CNX Nifty index.

The result of this work is remarkably simple:

 The correct size is to use is 50.

  Stocks considered for the S&P CNX Nifty must be liquid by the 'Impact cost
criterion.
 The largest 50 stocks that meet the criterion go into the index.

The nifty is uniquely equipped as an index for the index market owing to its

 Low market impact cost

 High edging effectiveness

Derivatives are financial products whose value is determined from one or more underlying
assets in a contractual manner. The underlying asset can be commodities or financial assets.
Derivative markets are working on the basis of spot price and future price. Derivative market
functions according to the agreements between parties to the contract. Major function of
Derivative contracts is risk management. The common underlying assets for derivatives are
equity shares, equity indices, debt market securities, interest rates, foreign exchange and
commodities. The major derivative exchanges in India include the following:

• Bombay stock exchange(BSE)

• National Commodity and Derivatives Exchange (NCDEX)
• National stock exchange(NSE)
• Multi Commodity Exchange(MCX)
Derivative is a contract or a product whose value is derived from value of some other asset
known as underlying. Derivatives are based on wide range of underlying assets. These include:

• Metals such as Gold, Silver, Aluminum, Copper, Zinc, Nickel, Tin, Lead
• Energy resources such as Oil and Gas, Coal, Electricity
• Agri commodities such as wheat, Sugar, Coffee, Cotton, Pulses and
• Financial assets such as Shares, Bonds and Foreign Exchange.

The factors driving the growth of equity derivatives are:

• Increased volatility in asset prices in financial markets

• Increased integration of national financial markets with the international markets
 • Development of more sophisticated risk management tools, providing economic
agents a wider choice of risk management strategies
• Innovations in the derivatives markets

DERIVATIVES: FINANCIAL WEAPON OF MASS DESTRUCTION

4.1 HISTORY

The origin of derivatives can be linked to the need of the farmers to protect their crops against
the fluctuations in the price of their crop. Earlier, from the time of sowing to the time of crop
harvest, farmers always faces uncertainties regarding the price of the commodity, but with the
introduction of derivative products farmers are in a position to hedge their price risk by locking
in asset prices. These happens on the basis of certain simple contracts between two parties one
can be a farmer and other can be a merchant or any other interested person to the contract.
With the help of these agreements the supplier is in a position to earn more when the prices
fall down because of high supply during harvest period.

The merchant or the second party to the contract also benefits from the derivative contracts.
The merchant is assured with the supply of certain commodities on a pre determined date for a
predetermined price. This helps him to secure himself from paying more amounts of cash for a
certain commodity in case of scarcity or low supply. In this way both the parties to the contract
will be benefitted from derivative contracts.

The concept of derivatives can be tied to the formation of Chicago Board of Trade (CBOT) in
1845 by a group of farmers and merchants with an aim to safeguard the interest of participants
of the board by predetermining the price of commodities with the help of lock in price. They
setup the world’s first commodity exchange under the name of CBOT in the year 1848.

The concept became very successful for hedging and speculating the price changes of various
commodities traded and in 1925, the first future clearing house came into existence.

Derivatives have been associated with a number of high-profile corporate events that shocked
the global financial markets over the past two decades. To some critics, derivatives have played
an important role in the near collapses or bankruptcies of Barings Bank in 1995, Long-term
Capital Management in 1998, Enron in 2001, Lehman Brothers in and American International

Group (AIG) in 2008 sub-prime crisis etc. Warren Buffet even viewed derivatives as time bombs
for the economic system and called them financial weapons of mass destruction. But
derivatives, if properly handled, can bring substantial economic benefits. These instruments
help economic agents to improve their management of market and credit risks. They also foster
financial innovation and market developments, increasing the market resilience to shocks.
Derivatives can be of two types mainly;

 Financial Derivatives
  Commodity Derivatives

4.2 EXCHANGE TRADED MARKETS

This is the market where individuals trade with standardized contracts that has been approved
by the exchange. People have been trading in derivatives exchanges since a long time. In 1848
Chicago Board of Trade (CBOT) was established to bring farmers and merchants together.
Initially their main duty was to standardize the quantities and qualities of the grains that were
traded. Within a very few years the first futures contract was developed and came to be known
as the to arrive contract. The speculators found trading in contracts as more attractive than
trading in grain itself. In 1919 Chicago Mercantile Exchange(CME) was established followed by
various exchanges all over the world. The CBE and CBOT were later emerged to form the CME
group, which also includes the New york mercantile exchange ,the commodity exchange
(COMEX) , and the Kansas city Board of Trade (KCBT).

The Chicago Board of Options Exchange started trading on call option contracts on 16 stocks in
1973 .Options were even traded prior to 1973 but CBOE could create an orderly market with
well defined contracts. Put options started trading on the exchange in 1977. The CBOE now
trades options on over 2500 stocks and many different stock indices. Traditionally derivative
exchanges have been using the open outcry system, wherein the traders physically meeting on
the floor of the exchange, shouting and by using various hand signals to indicate the trades that
they would like to place .This open outcry system has been largely replaced by the electronic
trading .Wherein the user enters the trade with the help of a computer terminal and places
their trade online. Electronic markets makes use of computer programs to initiate trades and
has led to a growth in high frequency and algorithm trading.

4.3 OVER -THE COUNTER MARKETS

This is not a physical market place but a collection of brokers and dealers, scattered across the
country. The main participants in OTC derivative markets are large financial institutions, banks,
fund managers and corporations. Once an OTC trade has been agreed, the two parties can
either present it to a central counterparty (ccp) or clear the trade bilaterally. A CCP takes up the
role of an exchange clearing house, it stands between two parties to the transaction so that one
party do not have to bear the risk of default from another party. Usually participants in the OTC
market have contacted each other through phone and email or finds a counter party through
an interdealer broker . OTC market is less regulated as the trades take place between qualified
and capable counterparties , who are supposed to take care of their trades. At the same time
exchange traded contracts are highly standardized contracts ,whose prices are determined by
the interaction of buyers and sellers on an anonymous auction platform. The clearing house
guarantees settlement of transactions. The number of derivatives transactions per year in OTC
market is smaller compared to that in exchange traded markets. But the average size of the
transactions in OTC market is much greater.

4.5 FINANCIAL DERIVATIVES

Section 2(ac) of securities contract Regulation Act (SCRA) 1956 defines Derivative as “a contract
which derives its value from the prices, or index of prices of underlying securities. Financial
Derivatives can be defined as financial instruments whose value is based on the performance of
assets such as stocks, bonds, currency exchange rates etc. The growing instability in the financial
markets helped the financial derivatives in gaining prominence after1970. The growing instability
includes the collapse of the Bretton Woods system of fixed exchange rates in 1971 which increased
the demand for hedging against exchange rate risk. The Chicago Mercantile Exchange allowed
trading in currency futures in the following year. Advancements in options pricing research, most
notably the Nobel-prize winning Black-Scholes options pricing model introduced in the year 1997,
provided a new framework for portfolio managers to manage risks. In recent years, the market for
financial derivatives has grown in terms of the variety of instruments available, as well as their
complexity and turnover. Financial derivatives have changed the world of finance through the
creation of innovative ways to understand , measure, and manage risk.

Applications Of Financial Derivatives

a. Management of risk: Risk management is not the elimination of risk but the
management of risk. Financial derivatives provide a powerful tool for limiting risks that
individuals and organizations face in the ordinary conduct of their business. It requires
a thorough understanding of the basic principles that regulate the pricing of financial
derivatives. Proper and effective use of financial derivatives can save cost and can also
increase returns.
b. Efficiency in trading : Financial derivatives allow for free trading of risk components
and that leads to improving market efficiency. Traders can use a position in one or
more financial derivatives as a substitute for a position in the underlying instruments.

c. The underlying instruments: In many instances, traders find financial derivatives to be

a more attractive instrument than the underlying security. This is mainly because of the
greater amount of liquidity in the market offered by derivatives as well as the lower
transaction costs associated with trading a financial derivative as compared to the costs
of trading the underlying instrument in cash market.

d. Speculation : Financial derivatives are considered to be highly risky .If not used
properly these can lead to huge financial destruction. But these are powerful
instruments for knowledgeable traders to expose themselves to calculated and well
understood risks for high returns.

e. Price Stabilization function : Derivative market helps to keep a stabilizing influence on

spot prices by reducing the short-term fluctuations.
4.6 EQUITY DERIVATIVES

An equity derivative is a derivative instrument whose value is derived from underlying assets
based on equity securities. An equity derivative's value will fluctuate with changes in its
underlying asset's equity, which is usually measured by share prices in the spot market. The
major types of equity derivatives are forwards, futures and options. A forward contract is a
contractual agreement between two parties to buy and sell asset at a certain time in future , at
a price decided on the date of the contract .A future contract is an agreement between two
parties to buy or sell an asset at a certain time in the future at a certain price. Options are
contracts that grant the right, but not the obligation to buy or sell an underlying asset at a set
price on or before a certain date. The right to buy is call option and the right to sell is put
option.

4.7 COMMODITY DERIVATIVES

Derivative contracts where underlying assets are commodities are called as commodity
derivatives. These underlying assets can include precious metals (gold, silver, platinum), agro
products (coffee, wheat, pepper, cotton), energy products ( crude oil, heating oil, natural gas)
etc. They help in future price discovery of underlying commodities. Here the trade is routed
through certain organized mechanisms. The major focus is that presently farmers are deciding
the commodity to be cultivated for next year is based on the price of the commodity in current
year.

Ideally this decision should be based on next year’s expected price. This can be obtained with
the help of the price discovery mechanism of commodity market.

4.8 PARTICIPANTS IN A DERIVATIVE MARKET

The following are the participants in a derivative market;

Fig 1

PARTICIPANTS

HEDGERS SPECULATORS ARBITRAGERS

  Hedgers

Hedgers face the risk associated with price of an asset. They use the futures or
options market to reduce or eliminate the risk. Derivative market with the help
of various instruments will transfer risk from person who have them but may
not like them to those who are ready to take it.

 Speculators
Speculators are people who bet on the future movement of the price of an
asset. Instruments like futures and options give them more leverage because by
keeping a small amount of money upfront, they can take large positions in the
market. Because of this leverage they increase the potential for large profits and
large gains.

 Arbitragers
Arbitragers works on the principle of taking the advantage of variations or
discrepancy in prices across markets. They usually take offsetting positions in
two different markets to lock in the profits. It happens when a trader purchases
an asset cheaply in one location and simultaneously arranges to sell it at a
higher price in another location.

4.9 DERIVATIVE INSTRUMENTS

 Forwards
Forward contracts are agreement between two parties who are agreed to
buy/sell the underlying at a future date at today’s predetermined price. Forward
contracts are not regulated by exchange and because of that they take place
over the counter. There are no formal rules for market stability, integrity and for
safeguarding the interest of market participants in these instruments.

 Futures
Future contracts are agreements between two parties to buy or sell some
underlying assets at a future date at today’s future price. They are exchange
regulated and hence over the counter transaction is not allowed. Futures are
standardized exchange traded contracts.
  Options
There are mainly two types of options;

 Call option: A call option gives the buyer the right not the obligation to
buy a given quantity of underlying asset at a given price on or before the
due date.

 Put option: A put option gives the seller the right not the obligation to
sell a given quantity of underlying asset at a given price on or before the
due date.

 Warrants
Option contracts generally have a life time of maximum twelve months. Most of
the option agreements are for nine months. Option contracts which are traded
for more than nine months are called warrants.

 Baskets:
Baskets options are options on portfolio of underlying assets. The underlying
asset will be the weighted average of the assets in the basket. Equity index
options are a form of basket options.

 Swaps:
Swaps are agreements between two parties to exchange cash flows in the
future according to some prearranged formula. There are mainly two types of
swaps namely interest rate swaps and currency swaps.

• Interest 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

SIGNIFICANCE OF DERIVATIVES

Like other segments of Financial Market, Derivatives Market serves following specific functions:
• Derivatives market helps in improving price discovery based on actual valuations and
expectations.
• Derivatives market transfers different risks from those who are exposed to risk but
have low risk appetite to participants with high risk appetite. Like hedgers want to give away
the risk where as traders are willing to take risk.
• Derivatives market helps shift of speculative trades from unorganized market to
organized market. Risk management mechanism provides stability to the financial system.
Various risks faced by the participants in derivatives

Market Participants must understand that derivatives, being leveraged instruments, have risks
like

 Counterparty risk (default by counterparty)

 Price risk (loss on position because of price move)
 Liquidity risk (inability to exit from a position)
 Legal or regulatory risk (enforceability of contracts)
 Operational risk (fraud, inadequate documentation, improper execution, etc.)

5. FORWARD CONTRACTS

It is an agreement made between two parties to buy / sell an asset on a specific date in the
future, at the conditions decided today. Forwards are widely used in equity, interest rate
markets, commodities & foreign exchange. The exchange happens at a specific price on a
specific future date and the price is fixed by both the parties on the day they enter into
contract. All the terms of the contract like price, quantity and quality of underlying, delivery
terms like place, settlement procedure etc. are decided on the day of entering in contract.

To understand better let’s take an example to understand basic difference between spot
market and forwards?

Assume on April 9, 2018 you wanted to purchase gold from a goldsmith. The market price for
Gold on April 9, 2018 was Rs. 14,425 for 20 gram and goldsmith agrees to sell you gold at
market price. You paid him Rs.14,425 for 20 gram of gold and took gold. This is a cash market
transaction at a price (in this case Rs.14,425) referred to as spot price. Now suppose you do not
want to buy gold on April 9, 2018, but only after 1 month. Goldsmith quotes you Rs.14,450 for
20 grams of gold. You agree to the forward price for 20 grams of gold and go away. Here, in this
example, you have bought forward or you are long forward, whereas the goldsmith has sold
forwards or short forwards.

There is no exchange of money or gold at this point of time. After 30 days, you come back to
the goldsmith pay him Rs. 14,450 and collect your gold.

This is a forward contract, where both the parties are obliged to go with the contract
irrespective of the value of the underlying asset (in this case gold) at the point of delivery.
Essential features of a forward are:

• It is a bilateral contract.
• All terms of the contract like price, quantity and quality of underlying, delivery terms like
place, settlement procedure etc. are decided on the day of entering in contract.

In other words, Forwards are bilateral over-the-counter (OTC) transactions where the terms of
the contract, such as price, quantity, quality, time and place are negotiated between two
parties to the contract. Any changes in the terms of the contract are possible only if both the
parties agree to it. Corporations, traders and investing institutions extensively use OTC
transactions to meet their specific requirements. The main objective of entering into a forward
is to cap the price and subsequently avoid the price risk. Thus, by entering into forwards, one is
assured of the price at which one can buy/sell an underlying asset. In the above-mentioned
example, if on May 9, 2018 the gold trades at Rs. 16,500 in the cash market, the forward
contract becomes favourable to you because you can then purchase gold at Rs. 14,450 under
the contract and sell in cash market at Rs. 16,500 i.e. net profit of Rs.2050. Similarly, if the spot
price is 13,390 then you incur loss of Rs. 60 (buy price – sell price).

Forward contracts on foreign exchange are also very popular. Most large banks employ both
spot and forward foreign exchange traders. Forward contracts are highly used to hedge foreign
currency risk .Let’s say, if you are planning to place a trade between GBP( great Britain pound)
and USD. Here GBP is the base currency and USD is the quote currency .Lets consider the spot
and forward quotes for the USD/GBP exchange rate on May 6 2018 as follows. On spot market
,the bid price was 1.5541 and offer price was 1.5545. For three months forward the bid price is
1.5533 and offer price is 1.5538. Suppose on May 6 2018 ,the US corporation is liable to pay
Euro 10 million in 3 months (august 6) .The corporation will agree to buy euro 10 million 3
months forward at an exchange rate of 1.5538. The corporation now has a long forward
contract on GBP and it has agreed to buy the sum from the bank for 1.5538 million. Thus the
bank now has a short forward contract on GBP.

PAYOFFS FROM FORWARD CONTRACTS

The payoffs can be positive or negative. This gives a better idea about the trader’s total loss and
gain. The payoff from a long position in a forward contract on one unit of an asset is denoted as
Pt-K . Where as the payoff from a short position in a forward contract on one unit is denoted as
K-Pt. where K is the delivery price and Pt denotes the price of asset at contract maturity.

In the above example , the contract obligates the corporation to buy euro 10 million for
1553800 dollars. If the spot exchange rate rose to 1.6000 , the corporation earns a profit of
46200 dollars. At the same time if the spot exchange rate fell to 1.5000 at the end of 3 months ,
the forward contract would give a loss of 53800.This would lead to the corporation paying
53800 more than the market price.
 Fig 2

5.2 MAJOR LIMITATIONS OF FORWARD CONTRACT

Liquidity risk:
As forwards are highly customized contracts i.e. the terms of the contract are according to the
specific requirements of the parties, other market participants may not be interested in these
contracts. The investment bank has to find a person who has an opposite view. The investment
bank does this for a fee.

Counterparty risk:
Counterparty risk is the risk of an economic loss from the failure of counterparty to fulfil its
contractual obligation.This happens when the counterparty defaults. This is also called as
default risk or counterparty risk.

Regulatory Risk :
The forwards contract agreement is executed by a mutual consent of the parties involved and
there is no regulatory authority governing the agreement .This may increase the incentive to
default.

Rigidity:
The rigidity of forward agreement is that they cannot foreclose the agreement halfway through.
Future contracts were then designed to reduce the risk of forward agreements.

OPTIONS CONTRACT
Options are traded in the Indian markets for over 15 years, but the real liquidity was available
only since 2006.An option is a tool for protecting your position and reducing risk. An option is a
contract that gives the right but not an obligation, to trade the underlying asset on or before a
stated date/day , at a stated price ,for a price. The party taking a long position i.e entering the
option is called buyer/holder of the option and the party taking a short position i.e selling the
option is called the seller/writer of the option.

A buyer of the call option has the right and the seller has an obligation to make delivery .The
option buyer has the right but not the obligation with regards to buying or selling the
underlying asset, while the option writer has the obligation in the contract.Therefore, option
buyer/ holder will exercise his option only when the situation is favourable to him, but, when
he decides to exercise, option writer would be legally bound to honour the contract. Options
may be categorized into two main types:-

Call Options: Options, which gives buyer a right to buy the underlying asset
Put Options: Options which gives buyer a right to sell the underlying asset

At the time of agreement the option buyer pays a certain amount to the option seller ,this is
called the premium amount. The agreement happens at a pre specified price called the strike
price.The option buyer benefits only if the price of the asset increases higher than the strike
price. If the asset price stays at or below the strike price ,the buyer does not benefit and thus its
always advisable to buy options when you really expect the prices would increase. Options are
cash settled in India. Similar to futures contract, options contract also have an expiry. They
expire on the last Thursday of every month. Option contracts have different expires- the
current month, mid month and far month contracts.

Buy a put option when you are bearish about the prospects of the underlying and when you
are bullish on the underlying one can either buy a call option or sell a put option. The maximum
loss the buyer of a call option experiences is to the extend of the premium paid. The loss is
experienced as long as the spot price is below the strike price. The call option buyer has the
potential to make unlimited profits provided the spot price moves higher than the strike
price.The point at which the call option buyer completely recovers the premium he has paid
that is called the breakeven point. The call option buyer truly starts making a profit only beyond
the break even point. Selling a put option required you to deposit a margin. When you sell a put
option your profit is limited to the extend of the premium you receive and your loss can
potentially be unlimited.
 Fig 3

6.1 OPTIONS TERMINOLOGY

a) Index option: Options having index such as Nifty, Sensex, etc. as an underlying asset.

b) Stock option: These options have individual stocks as the underlying asset. For
example, option on ONGC, NTPC etc.

c) Buyer: Option Buyer is the one who has a right but not the obligation in the contract.
For owning this right, he pays a price to the seller of this right called ‘option premium’.

d) Writer: Option writer is one who receives the option’s premium and is thereby obliged
to sell/buy the asset if the buyer of option exercises his right.

e) Option price/Premium: It is the price which the option buyer pays to the option seller.
In the above screenshot of nifty option, the premium amount is 1207.95.

f) Lot size: Lot size is the number of units of underlying asset in a contract. Lot size of
Nifty option contracts is 50.

g) Expiry Day: It is the day on which a derivative contract expires. It is the last trading
date/day of the contract. In our example, the expiration day of contracts is the last
Thursday of every month i.e. for current month options will expire on 26 April, 2018.
 h) Spot price (S): 10404.50 is the spot price for nifty here in the above example. It is the
price at which the underlying asset is traded at the spot market.

i) Strike price or Exercise price (X): strike price for 9200 Call option is 9200. It is the
price per share for which the underlying security may be purchased or sold by the
option holder.

j) In the money (ITM) option: This option would give holder a positive cash flow, if it
were exercised immediately. A call option is said to be ITM, when spot price is higher
than strike price. And, a put option is said to be ITM when spot price is lower than
strike price.

k) At the money (ATM) option: At the money option would lead to zero cash flow, if it
were exercised immediately. Therefore, for both call and put ATM options, strike
price is equal to spot price.

l) Out of the money (OTM) option: In other words, this option would give the holder a
negative cash flow if it were exercised immediately. A call option is said to be OTM,
when spot price is lower than strike price. And a put option is said to be OTM when
spot price is higher than strike price.

m) Intrinsic value: Option premium, defined above, consists of two components - intrinsic
value and time value. For an option, intrinsic value refers to the amount by which
option is in the money i.e. the amount an option buyer will realize, before adjusting for
premium paid, if he exercises the option instantly.

n) Time value: It is the difference between premium and intrinsic value, if any, of an
option. ATM and OTM options will have only time value because the intrinsic value of
such options is zero.

o) Open Interest: As discussed in futures section, open interest is the total number of
option contracts outstanding for an underlying asset. For example 9200 CE has an open
interest of 68475.

The table below shows the list of stock options registered under national stock exchange. The
table also contains the respective underlying asset, expiry date , strike price and also data on
open, high, low, prev close and last price.
 . FUTURES CONTRACT
Futures markets were innovated to overcome the limitations of forwards. A futures contract is
an agreement made through an organized exchange to buy or sell a fixed amount of a
commodity or a financial asset on a future date at an agreed price. Simply, futures are
standardized forward contracts that are traded on an exchange. The clearinghouse associated
with the exchange guarantees settlement of these trades. A trader, who buys futures contract,
takes a long position and the one, who sells futures, takes a short position. The words buy and
sell are figurative only because no money or underlying asset changes hand, between buyer
and seller, when the deal is signed. Mostly future contracts are cash settled thus there is no
worry of moving the asset from one place to another and there is total transparency in the cash
settlement.

The futures agreement inherits the transactional structure of the forwards contract. A futures
agreement derives its value from its corresponding underlying asset in the spot market. For
example TCS futures derives its value from the underlying in the TCS share market. These are
highly standardized contracts whose variables are predetermined- lot size and expiry date.

a) To enter into a futures agreement one has to deposit a margin amount ,which is a
certain percent of the contract value. Margin allows us to deposit a small amount and
take exposure to a large value transaction and hence leveraging on the transaction.
b) When we transact in a futures contract ,we digitally sign the agreement with the
counter party and thus becomes obliged to honor the contract upon expiry.
c) The futures agreement is then tradable, the trader can hold it till the expiry or trade it
in between. The trader can take a long position if he expects the price to go up and can
go for a short if the prices will go down.
d) Equity futures are always cash settled. Future agreements are called zero sum game
because it allows one to transfer money from one pocket to another.
In the futures market ,all the trades are regulated by the exchange .The exchange in return
takes the burden of guaranteeing the settlement of all the trades. The exchange makes sure
that the people who are entitled to profits receive the same and also they ensure that they
collect the money from the party who is supposed to pay up. They do this by collecting the
margins and by marking the daily profits or losses to the market. The futures market in India is
regulated by SEBI securities and exchange board of India.

7.1 FEATURES OF FUTURES CONTRACT

In futures market, exchange decides all the contract terms of the contract other than price.
Accordingly, futures contracts have following features:
• Contract between two parties through Exchange
• Centralised trading platform i.e. exchange
• Price discovery through free interaction of buyers and sellers

• Margins are payable by both the parties

• Quality decided today (standardized )
• Quantity decided today (standardized)

7.2 FUTURES TERMINOLOGY

a) Underlying asset: An underlying asset is a financial instrument from which a derivative

derives its value.Underlying assets can be metals ,agricultural commodities ,stock, index
etc. The futures price completely mimics the underlying as when the price of
underlying goes up the price of futures also rises. Likewise when the price of underlying
goes down the future price also comes down.

b) Spot price: This is the price at which the asset trades in the regular market or spot
market.It is the current market price.For example if we are talking about gold as an
underlying then the price of gold in spot market is spot price and gold in futures market
is called gold futures.

c) Future Price: The price at which the asset is traded at futures market.

d) Lot Size : Futures is a standardized contract where everything related to the

agreement is predetermined. Lot size is one such parameter. Lot size specifies the
minimum quantity that you will have to transact in a futures contract. Lot size varies
from one asset to another.
 e) Contract Value : Futures contracts are traded in lots and to arrive at the contract
value we have to multiply the price with contract multiplier or lot size or contract size.
Contract value = Futures price *Lot size.

f) Margin: Margin amount is a percent of contract value that is paid as a token advance
in the beginning. It is paid for entering into the contract. Margin allows investors to
deposit a small amount of money and take exposure to a large value transaction. This
initial margin includes span margin and exposure margin.

a. At the time of initiating the futures position , margins are blocked in one’s trading
account.
b. The margins that get blocked are called the initial margin.
c. The initial margin is made up of span margin and exposure margin
d. Initial margin will be blocked in your trading account for how many ever days the
trader choose to hold the trade.

g) Expiry :Future contracts are time bound .The expiry date of the futures contract is the
date upto which the agreement is valid. It is the date till which the one can hold the
future agreement. All derivative contracts in India expire on the last Thursday of the
month.

h) Open Interest: Open interest is the total number of open or outstanding (not closed or
delivered) options and/or futures contracts that exist on a given day, delivered on a
particular day. It gives an idea of how many contracts are open and live in the market.

i) Hedging: This is a technique to ensure that your position in the market is not affected
by any adverse movements. When a position is hedged it becomes neutral to the
overall market position and thus this will neither make money nor lose money.

j) Bid and Ask prices :Bid prices are those provided by buyers who want to buy shares
or futures .Ask prices are those quoted by sellers who want to sell shares or futures or
other products at these prices, The difference between the ask and bid price is called as
the spread.

k) Mark To Market (M2M) :Marking to market or mark or market is a simple accounting

procedure which involves adjusting the profit or loss you have made for the day.

7.3 KINDS OF TRANSACTIONS IN FUTURES

• Opening buy means creating a long or buy position ,this happens when the investor
believes that the stock prices would rise
 • Opening Sell means creating a Short Position .When we believe that the price of stock is
going to decline ,we opt for a short position.
• Closing Buy means offsetting (fully or partly) an earlier Short Position
• Closing Sell means offsetting (fully or partly) an earlier Long Position
Square off is closing an existing futures position. The square off for a buy open position
would be to sell and the square off for for a sell is to go for a long position.

The table below shows the list of stock futures registered under National Stock Exchange. The
table also contains the respective underlying asset, expiry date , strike price and also data on
open, high, low ,previous close and last price.

4 CURRENCY FUTURES

The future contracts on various currency pairs are knows as currency futures. Currently the
future contracts that are available are : USD/INR, EURO/INR, GBP/INR and JPY/INR. These
contracts are allowed to be traded on NSE and MCX. The contracts are very similar in nature
and have to be cash settled .Some of the contract details are as follows :

The symbols are USDINR ,EURINR, GBPINR and JPYINR , respectively. The underlying asset here
is actually the exchange rate of the respective currencies in Indian rupees; It is the exchange
rate for USD 1 in INR , EURO 1 in INR ,GBP 1 in INR and JPY 100 in INR.One unit of trading in
currency futures denotes USD 1000 and the tick size is INR 0.0025(i.e 0.25 paisa ). The contract
can be traded between 9am and 5:00 pm Monday to Friday .The contract trading cycle is a 12
month trading cycle with the last trading day being two working days prior to the last business
day of the expiry month of the contract at 12:00 noon .

The final settlement day is the last working day (excluding Saturday ) of the expiry month.The
base price is the theoretical price on the first day of the contract ; for all other days it is the
daily settlement price , which is calculated based on the last half an hour weighted average
price.The final settlement price is the Reserve Bank of India reference rate .Also the contract
follows a

“T+2” cycle for the final settlement.

The position limits for trading members are as follows :

 For USD/INR contracts , the limit is 15% of the toal open position or USD 50 million
whichever is higher
 For EUR/INR contracts ,the limit is 15% of the total open position or Euro 25
million,whichever is higher
 For GBP/INR contracts ,the limit is 15% of the total open position or GBP 25 million ,
whichever is higher
 For JPY/INR contracts , the limit is 15% of the total open position or JPY 1000 million ,
whichever is higher.

The minimum initial margin is based on SPAN and the extreme loss margin is

• 1% of the mark to market value of all open positions for USD/INR

• 0.3% of the mark to market value of all open positions for EUR/INR
• 0.5% of the mark to market value of all open positions for GBP/INR
• 0.7% of the mark to market value of all open positions for JPY/INR

7.5 SPECULATION USING FUTURES

Speculation is basically the act of trading in an asset that has a significant risk of losing money
with the expectation of making a gain. The speculators wishes to take a position in the market.
So speculators will either bet that the price of the asset will go up or they will bet that the price
of the asset will go down.

Lets consider a US speculator who in march thinks that the British pound will strengthen
relative to the US dollar over the next two months and is planning to invest to the extend of
250000 pounds. One thing the speculator can do is to purchase 250000 pounds in spot market
in the hope that the sterling can be sold at higher prices in the future market. Another
alternative is to take a long position in four CME May futures contracts on sterling. Each
futures contract is worth 62500 pounds.
 Buy 250000 pounds Spot Buy 4 futures contracts Future
price=1.5470 price=1.5410
Investment $386750 $20000
Profit if May spot =1.6000 $13250 $14750
Profit if May spot=1.5000 -$11750 -$10250

The above table gives a picture about the profits and losses made on both the alternatives. If
the rate increases to 1.6000 dollars per pound in May, the futures contract alternative enables
the speculator to realize a profit of (1.6000-1.5410) *250000 = $14750.

The spot market alternative leads to 250000 units of an asset being purchased for $ 1.5470 in
March and sold for $1.6000 in April , so that a profit of ( 1.6000-1.5470 )*250000=$13250
would be made. At the same time consider a situation where the exchange rate falls to 1.5000
dollars per pound. The futures contract gives rise to a loss of ( 1.5410-1.5000)*250000= $10250
and the spot market alternative gives rise to a loss of (1.5470-1.5000) =$11750 .Thus it
becomes very evident from the example that the futures alternative is favourable.The initial
investment that was made in the spot market for buying sterlings were 250000*1.5470=$
386750 .Whereas the investor just had to deposit a small sum of amount in the margin account.
It was $5000 for one contract and thus $20000 for four futures contract.

7.6 OPERATION OF MARGIN ACCOUNTS

One of the most important role of exchange is to organize trades , so that contract defaults are
avoided .This is where margin accounts comes into picture. Margin allows us to deposit a small
amount of money and takes exposure to a large value of transaction , thereby helping the
trader to leverage on the transaction. The exchanges set the margin levels and are constantly
required to review the rates as per the market volatility. The margin amounts can go up and
down as well. The forwards market doesn’t have a regulator, but all the trades in futures
market are routed through the exchange. The exchange here in return takes the burden of
guaranteeing the settlement of all the trades. The exchange makes sure that the deserving
party receives the amount . They ensure that they collect the money from the right party who is
supposed to pay up.

At the time of initiating a futures position, the margins are blocked in the trading account .The
margins that get blocked is called the initial margin .The initial margin is actually a combination
of the Span margin and exposure margin. Initial margin would be blocked in the trading account
for how many ever days you choose to hold the futures trade .Span margin or maintenance
margin is the minimum requisite margins blocked as per the exchange’s mandate .

Exposure margin is blocked over and above the span to cushion for any mark to market losses.It
is collected as per the broker’s requirement .Both span and exposure are specified by the
exchange. Span margin is more important as not having this in your account may lead to a
penalty in the exchange .As the volatility rises , the span margin also rises. The moment the
cash balance falls below the maintenance margin , they will call you asking you to pump in
more money .In the absence of which they will force close the positions themselves .This call
the broker makes requesting to pump in money is called the margin call. The margins vary from
one underlying to the another.

To illustrate how margin accounts work , we can consider an investor who contacts his broker
to buy two December gold futures contracts.We can take current future price as 1450 per
ounce . As the contract size is 100 ounces, the investor is required to buy a total of 200 ounces
at this price. The broker will require the investor to deposit funds in a margin account .This fund
deposited at the time of entering into the contract is known as initial margin .Let’s suppose thus
us 6000 per contract and 12000 in total here .At the end of each trading day , the margin
account is adjusted to reflect the investor’s gain or loss .This is known as the daily settlement or
marking to market .

Suppose at the end of first day the futures price has dropped by $9 from $1450 to $1441. The
investor here will have a loss of $ 1800 (200*9) , because the gold can now only be sold at
$1441. The balance in the margin account will reduce to 10200 from 12000.A trade is first
settled at the close of the day on which it takes place .It is then settled at the close of trading on
each subsequent day.The investor has the full right to withdraw any balance in the margin
account in excess of the initial margin.

The daily settlement is not just an arrangement between broker and client. Whenever there is a
decrease in futures price , the margin account of an investor with long position would be
reduced by that specific amount. In the example given here $1800 would be reduced from the
investor’s account. The investor’s broker has to pay the exchange clearing house $1800 and this
money is passed on to the broker of an investor with a short position. Similarly when there is an
increase in the futures price ,brokers for parties with short positions pay money to the
exchange clearing house and brokers for parties with long positions receive money from the
exchange clearing house.

The exchange ensures that the balance in the margin account never becomes negative with the
help of maintenance margin, which would be somewhat lower than the initial margin. At this
point when 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 by the end of the next day.The extra funds deposited are known as a variation
margin .If the investor does not provide variation margin ,the broker closes out the position.
Here in the example , closing out the position involves selling off 200 ounces of gold for delivery
in December.

The table given below illustrates the operation of margin account for one possible sequence of
futures prices.The maintenance margin is assumed to be $4500 per contract or $9000 in total
.On day 7 the balance in the margin account falls $1020 below the maintenance margin
level.This leads to a margin call and the investor is supposed to add up $4020 to bring the
account balance upto the initial margin level of $12000.The investor here provides this margin
by the close of day 8. The contract is entered into on day 1 at $1450 and closed out on Day 16
at $1426.90.The margin is the only factor that provides confidence to market participants that
others will meet the obligations on time.

Table 1

Day Trade Price Settlement Daily Gain Cumulative Margin Margin

Price Gain Account Call
Balance
1 1450 12000
1 1441.00 -1800 -1800 10200
2 1438.30 -540 -2340 9660
3 1444.60 1260 -1080 10920
4 1441.30 -660 -1740 10260
5 1440.10 -240 -1980 10020
6 1436.20 -780 -2760 9240
7 1429.90 -1260 -4020 7980 4020
8 1430.80 180 -3840 12180
9 1425.40 -1080 -4920 11100
10 1428.10 540 -4380 11640
11 1411.00 -3420 -7800 8220 3780
12 1411.00 0 -7800 12000
13 1414.30 660 -7140 12660
14 1416.10 360 -6780 13020
15 1423.00 1380 -5400 14400
16 1426.90 780 -4620 15180

7. LEVERAGE

Futures are highly leveraged products , this one factor makes futures more appealing and also
a risky venture. Leverage here in futures trading means that the traders here have to pay only a
small amount to the exchange to control a lot of product. The margin amount is only a small
percentage of the contract value .This small amount facilitate the investors to take exposure for
a large value transaction. The higher the leverage, the higher is the risk and the higher is the
profit potential.

The higher the leverage the higher is the risk .When leverage is high ,only a small movement in
the underlying is required to wipe out the margin deposit

Let’s understand the role of leverage in a better way with the help of an example considering
two situations. Take for example , Mr M plans to buy shares of Infosys in spot market to the
extend of 100000 . On 30th April 2018 , the Infosys share is traded at a price of 1168. Thus Mr M
can afford to buy 86 shares of Infosys.
100000/1168 = 86

Now on May 7th , when Infosys is trading at 1300 .Mr M can square off the position for a profit
of 11800 on investing 100000.

86*1300 =111800 ,

The return percentage would be 11800/100000=.1180 or 11.80 %

A return of 11.80 % on a 7 days time is a great thing. Now lets look at another alternative when
Mr M decides to buy Infosys futures of 100000 worth in futures market .The minimum number
of shares that needs to be bought in Infosys is 125 or in multiples of 12 .Thus the contract value
is the lot size multiplies by the futures price .In this case the futures price is 1168 per share ,
hence the contract value becomes
125 *1168=146000. Here he doesn’t have to pay the entire contract value instead he only pays
the margin amount and can enter the trade .The margin amount is a certain percent of
contract value and here when we take a 14% , it happens to be 146000 *14%=20440. Thus Mr
M can easily take 4 lots of the contract instead of 1 lot .Thus with 4 lots of Infosys futures the
number of shares would be 500 (125*4)- at the cost of 81760.

Futures contract value at the time of buying =Lot size * number of lots *Futures Buy price
=125*4* Rs 1168

=Rs 584000/-

Margin amount – Rs 81760

Futures Sell price = 1300

Futures contract Value at the time of selling = 125 *4*1300 =Rs 650000

Thus a profit of Rs 66000

Hence the return percent becomes [66000/81760] *100 =80.72%

That’s becomes a large amount of profit from Infosys futures .Thus the investor can earn a
return of 80.72% from investing in futures market . The same person could only earn an approx.
12% return from investing in the spot market of the same security. Thus by virtue of
margins,the investors can take positions much bigger than the actual capital available , this is
called “Leverage”. Its like a double edged sword, if used in the right spirit and knowledge , it can
lead to the creation of wealth or else can even wipe out your account. The higher the leverage
,the higher is the risk associated with the trade. When you are trading with a high leverage ,only
a small move in the underlying is required to wipe out the margin deposit.

LEVERAGE CALCULATION

The leverage calculated as follows :

Leverage =Contract value / Margin

Hence for the above Infosys trade the leverage one lot is

146000/20440 =7.14

This means every Re 1 in the trading account can buy upto Rs7.14 worth of Infosys. This is a
very manageable ratio.However if the leverage increases then the risk also increases. At 7.14
times leverage , Infosys has to fall by 14% for one to lose all the margin amount ,this is
calculated as follows – =1/7.14

=14%

Now for a moment assume the margin requirement was just Rs 5000 ,instead of 20440 .In this
case the leverage would be

=146000/5000

=29.2 times

This is clearly a very high leverage ratio ,the investor would lose all his capital if Infosys falls by
1/29.2

=3.4%

Here is this case , a 3.4% move in the underlying is enough to wipe out all your margin
deposit.Alternatively , at 29.2 times leverage one just need a 2.4% move in the underlying to
double your money.Thus the higher the leverage ,the higher is the risk. From the above
calculations its evident that , the more the margin the less would be the leverage associated
with it .Whereas when the margin amount is less , the leverage would be high and thus more
risky.

7.8 PAY OFF STRUCTURE

The payoff structure plots a graph of the possible price on the day you bought the share versus
the buyer’s profit and loss. In case of a long position -Any price above the buy price results in a
profit an any price below the buy price results in a loss.If the trader has initiated a short
position – then any price below the short price will result in a profit and any price above the
short price lead to a loss.Since the traders here takes place trades in lots , just one point price
movement results in a gain of (1* lot size ) and the same with a one point negative movement.
The proportionality comes from the basic fact that the money made by the buyer is the loss
suffered by the seller. The profit and loss is a smooth straight line thus its called as a linear pay
off instrument.

The pay off for buyers of futures contract is similar to the pay off for a person who holds an
asset. He has a potentially unlimited upside and downside as well. Consider for example the
case of a speculator who buys a two month Nifty Index futures contrtact 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 giving profits and when the index moves down it starts making
losses.

The graph below represents the pay off structure for futures during a long position. If SPm is
the spot price on maturity and PP is the purchase price ,then the pay off on a long position per
one unit of the asset is “SPM-PP”.
 Fig 6

The payoff for a person who sells a future contract is similar to the payoff for a person who
shorts an asset .For example take the case of a speculator ,who sells a two month Nifty index
futures contract when the nifty stands at 1290 .The underlying asset in this case is the nifty
index. When the index moves down ,the short futures position start making profits and when
the index moves up , it starts making losses.

If SPm is the spot price on maturity and PP is the purchase price ,Then the pay off on a short
position per one unit of the asset is “PP-SPm “ .
 Fig 7

7.9 HEDGING WITH FUTURES

A majority of the investors in futures market are hedgers . Their main motive is to use futures
markets to reduce a particular risk that they face. Hedging position is undertaken by the
investors inorder to eliminate the risk. When an individual or company chooses to use futures
market to hedge a risk , the objective is to take a position that neutralizes the risk as far as
possible .

Lets consider an example where an investor takes an hedging position against a single stock.
Imagine if we bought 250 shares of Infosys at 2300 per share .This works out to be an
investment of 575000. Here the investor is long on Infosys shares in the spot market.

After initiating this position , the investor realize that the quarterly results are expected
soon.The investor is worried that Infosys may announce a not so favorable set of numbers , as
a result of which the stock price may decline considerably .To avoid making a loss in the spot
market , the investor decides to hedge the position.

Thus , in order to hedge the position in spot market , the investor here took a short position in
the futures market for 250 shares at a price of 2301 per share.Thus the contract value becomes
575250 and the lot size is 250 . Now on one hand the investor is long on Infosys in spot market
and on the other hand he is short on Infosys on futures market.Thus the investor could create a
neutral position here.
Arbitrary price Long on spot Short on Futures Net P & L
P&L P&L
2200 2200-2300= -100 2301-2200= 101 -100+101= 1

2400 2400-2300= 100 2301-2400= -99 100-99= 1

2550 2550-2300= 250 2301-2550 = -249 250-249 =1

Fig 8

In the above figure , the investor has taken a long position in the spot market and a short
position in the futures market. The above example neither make money nor lose money , the
overall position is frozen here. In fact the position becomes indifferent to the market , this is
why we say when a position is hedged it stays neutral to the overall market conditions .
Hedging can be undertaken by buying in the spot market and selling in the futures market or
else by taking a long position in the futures market and shorting in the spot market.

Short hedge

A short hedge is a hedge , which involves a short position in future contracts .A short hedge is
appropriate when the hedger already owns an asset and expects to sell it at some time in the
future. Consider an example , assume that it is May 15 today and that an oil producer has has
just negotiated a contract to sell 1 million barrels of crude oil .It has been agreed that the price
that will apply in the contract is the market price on August 15.The oil producer is therefore in
the position where it will gain $10000 for each 1 cent increase in the price of the oil over the
next three months and lose $ 10000 for each 1 cent decrease in the price during this period .
Suppose that on May 15 the spot price is $80 per barrel and the crude oil futures price for
august delivery is $79 per barrel, Because each futures contract is for the delivery of 1000
barrels, the company can hedge its exposure by shorting 1000 futures contract .If the oil
producer closes out its position on August 15, the effect of the strategy should be to lock in a
price close to $79 per barrel.

Suppose if the spot price on August 15 proves to be $75 per barrel .The company realizes $75
million for the oil under its sales contract .Because August is the delivery month for the futures
contract , the futures price on August 15 should be very close to the spot price of $75 on that
date. The company therefore gains approximately

$79-$75 = $4 per barrel or $4 million in total from the short futures position. The total amount
realized from both the futures position and the sales contract is therefore approx. $79 per
barrel or $79 million in total. Suppose the price of oil on August 15 proves to be $85 per barrel
.The company realizes $85 per barrel for the oil and loses approximately $85-$79=$6 per barrel.
Again the total amount realized is approximately $79 million .

Long Hedges

Hedges that involve taking a long position in a futures contract are known as long hedges. A
long hedge is appropriate when a company knows it will have to purchase a certain asset in the
future and wants to lock in a price now. Lets consider an example ,assume that it is January 15
now.A copper fabricator knows it will require 100000 pounds of copper on May 15 to meet a
certain contract .The spot price of copper is 340 cents per pound , and the futures price for may
delivery is 320 cents per pound .The fabricator can hedge its position by taking a long position
in four futures contracts offered by the COMEX division of the CME group and closing its
position on May 15.Each contract is for the delivery of 25000 pounds of copper .The strategy
has the effect of locking in the price of the required copper at close to 320 cents per pound.

Suppose that the spot price of copper on May 15 proves to be 325 cents per pound. Because
May is the delivery month for the futures contract , thus should be very close to the futures
price .The fabricator therefore gains approximately 100000 *( $3.25 -$3.20)= $5000 on the
futures contract.

It pays 100000 *$ 3.25= $ 325000 for the copper ,making the netcost aprroximately
$325000$5000 = $ 320000. For an alternative outcome , suppose that the spot price is 305
cents per pound on May 15. The fabricator then loses approximately 100000 *($3.20- $3.05)
=$15000.

On the futures contract and pays 100000 * $3.05 = $305000 for the copper .Again , the net cost
is approximately $320000 or 320 cents per pound.
7.10 OPEN INTEREST

The open interest is the total number of open or outstanding contracts on a particular day. It
gives the investors an idea about all the open and live positions in the market.When a buyer is
said to be long on a position and the seller is said to be short on the same contract , then the
open interest becomes one.The open interest helps the investors in knowing about the liquidity
in the market. The more the open interest the more would be the liquidity .Thus it helps the
traders to enter and exit trades at competitive bid/ask rates.

Fig 9

Just have a look at the above snapshot . As of May 7 2018 , the open interest on nifty futures is
2.38 crores . The change is open interest gives data on the number contracts added on a
particular day .Here a total 244125 contracts have been added or that make up a 1.03% on 2.38
crores.People gets confused with volumes and open interests . Volumes starts from zero every
day whereas open interest is not discrete like volumes. It gets on increasing and decreasing
based on the entry and exit orders of traders.

When there is an increase in both the price and volume , the market is tend to be bullish.When
both the price and volume are decreasing the traders will will think that the bearish trend could
probably end can expect a reversal. Another situation can be when the price decreases along
with an increase in the volume ,this leads to a bearish trend. The status of open interest can
give a sense of strength between bullish and bearish positions. If there is an abnormally high
open interest backed by a rapid increase or decrease in prices , then the investor has to be
cautious as a very small trigger can lead to a lot of panic in the market. Now lets look at the
trader’s perception when there is a change in the price of the stock and the open interest

Price Open Interest Trader’s Perception

Increase Increase More trades on the long side
Decrease Decrease Longs are covering up their positions ,long unwinding
Decrease Increase More trades on the short side ,bearish
Increase Decrease Shorts are covering their position , short covering

7.11 DELIVERY

A very few futures contracts that are entered into lead to delivery of the underlying asset. Most
are closed out early The period during which delivery can be made is defined by the exchange
and varies from contract to contract .The decision on when to deliver is made by the party with
the short position,whom we can refer here as investor A .When this investor A decided to
deliver , investor A’s broker issues a notice of intention to deliver to the exchange clearing
house. This notice states how many contracts will be delivered and in the case of commodities
,it also specifies where delivery will be made and what grade will be delivered. The exchange
then chooses a party with a long position to accept delivery .

Suppose that the party on the other side of investor A’s futures contract when it was entered
into was investor B. It is very important to know that , its not necessary to expect investor B to
take the delivery .Investor B may have closed out his or her position by trading with investor C.
Same with investor C as well , investor C must have closed his or her position by trading with
investor D and so on. The usual rule of the exchange is to pass the notice of intention to deliver
on to the party with the oldest outstanding long position. Parties with long positions must
accept delivery notices. However, if the notices are transferable ,the long investors have a
short period of time , usually half an hour , to find another party with a long position that is
prepared to take delivery in place of them.

In case of commodities ,taking delivery usually means accepting a warehouse receipt in return
for immediate payment .The party taking delivery is then responsible for all warehousing
costs.In the case of livestock futures , there may be costs associated with feeding and looking
after the animals. In the case of financial futures, delivery is usually made by wire transfer .For
all contracts ,the price paid is usually the most recent settlement price. If specified by the
exchange , this price is adjusted for grade , location of delivery and so on .The whole delivery
procedure from the issuance of the notice of intention to deliver to the delivery itself generally
takes about two to three days.

There are three critical days for a contract .These are the first notice day , the last notice day
and the last trading day.The first notice day is the first day on which a notice of intention to
make delivery can be submitted to the exchange .The lase notice day is the last such day .The
last trading day is generally a few days before the last notice day .To avoid the risk of having to
take delivery, an investor with a long position should close out his or her contracts prior to the
first notice day. A futures contract is referred to by its delivery month .The exchange must
specify the precise period during the month when delivery can be made. For many futures
contracts , the delivery period is the whole month .The delivery months vary from contract to
contract and are chosen by the exchange to meet the needs of market participants. At any
given time, contracts trade for the closest delivery month and a number of subsequent delivery
months.

7.12 CASH SETTLEMENT

Mostly all the financial futures are cash settled , such as those on stock indices are settled in
cash because it is inconvenient or impossible to deliver the underlying asset .In the case of
futures contract on the S&P 500 , for example delivering the underlying asset would involve
delivering a portfolio of 500 stocks. When a contract is settled in cash, all outstanding contracts
are declared closed on a predetermined day.The final settlement price is set equal to the spot
price of the underlying asset at either the open or close of trading on that day.

Technical analysis
The technical analysis helps to identify the trading opportunities using actions of market
participants through charts, indicators and patterns. The concept of technical analysis can be
used to analyse any asset class – equities, foreign exchange, commodities etc. The few key
assumptions of technical analysis are market discounts everything, price moves in trends and
history tends to repeat itself. The types of charts used to analyse trade patterns are bar charts,
line charts and Japanese candle stick charts. The Japanese candle stick charts are the most
popular and the widely used charts to analyse any market. In a Japanese candle stick chart,
strength is represented by a bullish candle and weakness by a bearish candle. Some of the
widely used indicators are Relative strength index , Fibonacci retracement , moving averages
and pivot point. Technical analysis can be used to analyse various underlying assets to decide
on a derivative trade with the help of various technical indicators. Because the prices of the
derivatives and their underlying assets moves in tandem. Technical analysis facilitates the study
and understanding of candle sticks and various technical indicators.

Fig 10

8.1 JAPANESE CANDLE STICK CHARTS

The earliest use of candlesticks dates back to the 18th century by a Japanese rice merchant
named Homma Munehisa. Though the candlesticks have been in existence for a long time in
Japan, the western world traders were clueless about it. In 1980’s a trader named Steve Nison
accidentally discovered candle sticks and he introduced this to the rest of the world. He
published the book named “Japanese candlestick charting Techniques” and the candle stick
techniques began to gain popularity in the 90’s. The Japanese candle stick charts are widely
used around the world to conduct technical analysis.

Japanese candle sticks can be used for any time frame including one day , one hour ,30 minutes
etc. The candle sticks are classified into bullish candle and bearish candle. The bullish candle is
mostly represented by green/blue/white and bearish as red/black. They are formed using the
high, low, open and close of the chosen time period. If the close is above the open ,then a
hollow/green candlestick is formed called a bullish candle. If the close is below the open , then
a red/ black candlestick is formed called a bearish candle. Bullish candle indicates strength and
thus it gives buy signals , whereas a bearish candle indicates weakness and thus go for a short.
Every candlestick consists of three components namely the
 • Central real body: The rectangular shaped real body that connects the opening and
closing price
• Upper shadow: connects the high to the close in case of bullish candle and connects
the high to the open for a bearish candle
• Lower Shadow: It connects the low to the open in case of a bullish candle and
connects the low to the close for a bearish candle.

8.2 SINGLE CANDLESTICK PATTERNS

8.2.1 MARUBOZU:

The marubozu is a candle with no upper and lower shadow. It will just have a real body. This
can be classified into bullish marubozu and bearish marubozu. When the open is equal to the
low and high is equal to the close, a bullish marubozu is formed. It shows that there is so much
buying interest in the market and the market participants are willing to buy the stock at every
price point during the day. In a bearish marubozu the open is equal to the high and the close is
equal to the low. It shows that there is so much selling pressure in the market and the
participants sold at every price point during the day.

Fig
11

8.2.2 THE SPINNING TOP:

These candles have a small real body with equal upper and lower shadows.It conveys indecision
and uncertainity as both bulls and bears were not able to influence the market. If the bulls were
successful then the real body would have been a long green candle.If the bears were successful
then the real body would be a long red candle.The presence of upper and lower shadow tells us
that the bulls and bears have tried their best. Whenever the spinning top pattern forms , the
traders will have to wait for the next price movement.In an uptrend if a bullish candle is
formed soon after the spinning top pattern at a support level ,the investor can go for a long
position .

Fig 12

8.2.3 THE DOJI

In doji candles the open price and the close price will be equal.The upper and lower shadow can
be of any size.Doji candles conveys indecisions and uncertainity , in this case the market can
swing in both ways. Prices move either above and below the open price during the session, but
close at or very near the open price.There are four types of Doji candles namely long legged
doji, dragonfly doji, gravestone doji and four price doji.
8.2.4 PAPER UMBRELLA

In a paper umbrella the length of the lower shadow should be at least twice the length of real
body. It appears with a small real body and a long lower shadow. A paper umbrella consists of
two trend reversal patterns namely the hanging man and the hammer .The hammer is a bullish
trend reversal pattern that forms during downtrend and the hanging man is a bearish trend
reversal pattern that appears in an uptrend. The chart below shows both the hanging man and
the hammer along with their respective trends.

Fig 14

THE HAMMER
This candle stick appears at the bottom end of a downward trend and is relatively bullish. The
length of the lower shadow be atleast twice the length of the real body.The low of the hammer
is taken as the stop loss.The true confirmation of a hammer candle can only be made when the
next proceeding candle closes with a higher low than the hammer candle. The price action on
the hammer formation day indicates that the bulls were reasonably successful in taking the
price higher. Thus traders can look for buying opportunities. The hammer is a bullish reversal
pattern and it’s named so as it acts like hammering out a bottom. The main points to be
considered include
  The long shadow has to be two or three times of the real body
 There would be little or no upper shadow
 The real body is at the upper end of the trading range
 The color of the real body doesn’t matter, but a bullish candle is mostly preferred.

Fig 15

8.2.5 THE HANGING MAN

This candlestick appears at the top end of a upward trend and is relatively bearish.The length of
the lower shadow should be atleast twice the length of the real body.The day the hanging man
candle appears , it shows that the bears have managed to make an entry.The hanging man
formation does not mean that the bulls have definitely lost control ,but it may be an early sign
that the momentum is decreasing and the direction of the asset may be getting ready to
change. It is more easily identified in intraday charts than daily charts.Thus it’s highly used by
intraday traders. Thus it suggests a short trade and the stop loss would be the high of the
hanging man.
 Fig 16

The main features to be noted while looking for an hanging man are as follows :

 A long lower shadow which is two to three times of the real body.
 Little or no upper shadow
 The real body has to be in the upper end of the trading range
 The colour of the body doesn’t matter , anyhow a bearish candle is more preferable.

8.2.6 INVERTED HAMMER

An inverted hammer is a bullish reversal candlestick .The inverted hammer is formed in the
downward trend. It appears with a longer upper shadow , which is atleast twice the body’s
length.The trader can think about taking a long position and the stop loss could be kept at the low of
the inverted hammer.It indicates that the bulls have made an entry and the buyers have tried to
take the price higher.
 Fig 17

8.2.7 THE SHOOTING STAR

This candlestick has a longer upper shadow and the length of the upper shadow is atleast twice
the length of the real body.It’s a bearish pattern and thus the prior trend has to be bullish. On
the day the shooting star pattern forms, the market would make a new high. But at the high
point ,there is a selling pressure which lead the price to close near the low point .Thus it
indicates that the bears have made an entry and they could push the prices down.Thus it gives
the trader selling opportunities and the stop loss to be kept at the high of the pattern.
 Fig
18

8.3 MULTIPLE CANDLESTICK PATTERNS

8.3.1 Bullish Engulfing Pattern :

It appears at the bottom of a downtrend and is considered to be bullish. Bullish engulfing

pattern evolves over two days , the first day of the pattern should be a red candle and the
second day candle would be a green candle.Its not necessary for the green candle to engulf the
shadows but the real body of the red candle would be completely engulfed.The traders can
initiate a long position and the stop loss has to be the lowest of the pattern.
8.3.2 Bearish Engulfing Pattern

This bearish pattern appears at the top end of an uptrend and thus the prior trend has to be
bullish.This is also evolved over two days , on the first day a bullish candle is formed followed
by a long bearish candle that completely engulfs it.This means that the sellers are more
powerful than the buyers and that the prices can come down.The traders can look for selling
oppurtunities and the stop loss has to be at the highest of the pattern.

Fig 19

8.3.3 THE PIERCING PATTERN

This is very similar to the bullish engulfing pattern with a small variation. In a piercing pattern
the green candle formed on the second day partially engulfs the red candle formed on the first
day. The engulfing happens between 50% and less than 100 %. The traders can look for buying
opportunities and the stop loss to be kept at the low of the pattern.

Fig 20
8.3.4 THE DARK CLOUD COVER

This is very similar to bearish engulfing pattern with a slight variation. In a dark cloud cover
pattern the red candle formed on the second day engulfs the green candle partially about 50%-
100% . The traders can look for selling opportunities and the stop loss would be the high of the
pattern.

Fig 21

8.3.5 THE HARAMI PATTERN

Harami is the old Japanese word for pregnant. Its a two candle pattern with the first candle
being usually long and the second candle has a small body. There are two types of harami
patterns –the bullish harami and the bearish harami.

a) THE BULLISH HARAMI

This candle is formed in a downtrend pushing the prices lower ,therefore giving the bears more
control over the market.But on the second day the market gains strength and thus manages to
close on a positive note , thus forming a green candle. The small green candle formed on the
second day appears pregnant within the long red candle.Traders can initiate a long position and
can keep the stop loss at the lowest low of the pattern.Risk takers can initiate a long trade
around the close of the green candle on second day.
b) THE BEARISH HARAMI
This candle is formed at the top end of an uptrend. A bullish candle is formed on the first day
and a red candle on the second day. The small red candle formed on the second day appears
pregnant within the long blue candle. The opening price of the red candle should be lower than
the closing price of the green candle. Traders can look for selling opportunities and the stop loss
to be kept as the highest high of the pattern. This picture shows the bullish and the bearish
harami respectively.

Fig 22

8.4 TRIPLE CANDLE STICK PATTERNS

8.4.1 THE EVENING STAR

This is a bearish candle stick pattern that evolves over a three day period and it appears at the
top of an uptrend. The first candle would be a bullish candle followed by a doji or spinning top
with a gap up opening. The third candle would be a bearish candle with a gap down opening
and the current market price should be lower than the opening price of first candle. The traders
can initiate a short position and the stop loss has to be the highest high of the pattern.

In an evening star pattern , the trader has to look for the following :

 The first candlestick is a bullish candle ,which is a part of a recent uptrend.

 The second candle must have a small body , this candle can either be bullish or bearish.
This candle shows perfect indecision in the market.
 The third candlestick is an absolute bearish one and it closes beyond the midpoint of
the first candle.
 Fig 23

8.4.2 THE MORNING STAR

This is a bullish candle stick pattern that evolves over a three day period and it appears at the
bottom of a downtrend. The first candle would be a bearish candle followed with a gap down
opening ,the second candle would either be a doji or a spinning top.The third candle would be a
bullish candle and the current market price being higher than the opening of the first
candle.The traders can look for buying opportunities and the stop loss has to be the lowest low
of the pattern.

A trader can look for the following signals in order to confirm regarding this pattern .

 The first candle is a bearish candle that is formed at the top of an uptrend
 The second candle is a small and indecisive candle stick. This can be a bearish or bullish
candlestick .
 The third candle is any long or bullish candle.
Fig 24

Fig 25
9. TECHNICAL INDICATORS
Technical indicators helps the investors to analyse the price movements of securities and hence
leads to more accurate trading decisions. Indicators are of two kinds mainly leading indicator
and lagging indicator. The leading indicator leads the price and thus it signals the occurrence of
a reversal or a new trend in advance. Lagging indicators lags the price and thus it usually signals
the occurrence of a reversal or a new trend after it has occurred. The trader has to be highly
alert while using technical indicators because no indicator can give complete true signals. The
efficiency of technical indicators also increases along with the trade experience. Some of the
most widely used indicators are Pivot points ,Fibonacci Retracement, Moving averages,
Bollinger Bands ,Relative strength Index and stochastic Oscillator.
 Fig 26

9.1 RELATIVE STRENGTH INDEX :

The relative strength index or RSI is a very popular indicator developed by J.Welles Wilder. RSI
is a leading momentum indicator which helps in identifying a trend reversal .RSI indicator
oscillates on a scale of 0 and 100, and based on the latest indicator reading , trade positions are
decided.

The formula to calculate the RSI is as follows

RSI = 100- 100/1+RS

RS= Average Gain /Average Loss

Wilder’s formula normalizes relative strength and turns it into an oscillator that fluctuates
between 0 and 100 .The Relative strength index indicator can be broken down into relative
strength , average gain and average loss. The RSI calculation is based on 14 periods ,which is the
default time frame suggested by Wilder .Losses are expressed as positive values , not negative
values.

The very first calculations for average gain and average loss are simple 14 period averages.First
average gain is the sum of gains over the past 14 periods divided by 14. And the first average
loss is the sum of losses over the past 14 periods divided by 14. The second set of calculations
are based on the prior averages and the current gain or loss. Here the Average gain =[(previous
average gain)*13+ current gain] /14.

Average loss=[(previous average loss )*13 +current Loss ] /14

Taking the prior value with the current value is part of smoothing technique similar to that used
in calculating the exponential moving average. The RSI values become more accurate as the
calculation period extends.The RSI is normally zero when the Average gain equals zero
.Assuming a 14 period RSI , a zero RSI value means price moved lower all 14 periods .There
wasn’t any gains to measure .The RSI is 100 when the average loss equals zero .This indicates
that the prices moved higher on all 14 periods and there were no losses to measure.

A value between 0 and 30 is considered oversold and thus the trader should start looking for
buying opportunities. Any value between 70 and 100 is considered to be overbought and the
trader can look for selling opportunities. If the RSI value is fixed in the overbought region for a
long period that shows an excess of positive momentum and the trader can go for a long
position .If the RSI value stays in the oversold region for a long time that shows the excess of
negative momentum and can thus go for a short.The below graph is the candle stick chart of
nifty futures along with RSI indicator.

Fig 27

Wilder says divergences signal a potential reversal point , thus RSI considers the bullish
divergence and bearish divergence as well. A bullish divergence occurs when the underlying
security makes a lower low and the RSI forms a higher low.The RSI indicator here is not
confirming the lower low and this shows strengthening momentum. A bearish divergence is
formed when the security records a higher high and the RSI forms a lower high .Here the RSI is
not accepting the newer high and thus shows the weakening momentum. The chart below
shows a bearish divergence during august –october and a bullish divergence during January –
March.

9.2 MOVING AVERAGES

The moving averages are one of the widely used technical indicators ,used to identify the
buying and selling oppurtunities. When the stock price trades above its average price ,it means
the traders are willing to buy the stock at a higher price than its average price. Therfore the
trader can look for buying oppurtunities. We use exponential moving averages to analyse the
market. For example take 50days EMA.The trader has to go for a long position ,when the
current market price turns greater than the 50day ema and can exit the long position when the
price is less than the 50 day EMA.Moving averages can be calculated on any time frame.

Simple moving averages (SMA), exponential moving average(EMA) and weighted moving
average (WMA) are the three types of moving averages. For stocks ,common time periods for
moving averages are 10 days ,21 days, 50 days, 100 days and 200 days. The most commonly and
widely used moving average is the simple moving average. Single simple moving average can be
used to identify a trend , but dual or triple moving averages combined together is more
powerful and effective.

Traders makes use of moving average cross over system ,by combining two moving averages of
different time frames. Thus is usually referred to as smoothing. The shorter moving average
(50day MA) takes lesser number of data points to calculate the average and hence it always
sticks closer to the current price. Whereas the longer moving average (100 day MA) takes more
data points to calculate the average and thus it tends to stay away from the current price.
When the short term moving average turns greater than the long term moving average, the
trader can take a long position. When the short term moving average turns lesser than the
longer term moving average, the trader goes for a short position. The entire outlook turns
bullish, when the faster EMA is above the slower EMA and it looks bearish when the faster EMA
is going below the slower EMA. The below graph is the candle stick chart of Nifty futures. The
green line on picture below indicates a 50 day moving average and the red line denotes a 100
day moving average.
 Fig 29

9.3 FIBONACCI RETRACEMENT

Under this indicator technical analysis is carried out with the help of certain ratios i.e 61.8%
,38.2% and 23.6%.These retracement level provide a good opportunity for the traders to enter
into new positions. This analysis is used by traders when there is a noticeable up- move or
down-move in prices. We should first identify the 100% Fibonacci move. This move can be an
upward or a downward rally. Traders need to pick the most recent peaks and trough on the
chart. Once these points are identified, these are connected using a Fibonacci Retracement
tool. These ratios act as a potential level upto which a stock can correct. This indicator enable
the traders to identify the retracement levels and therefore helps to position accordingly. This
indicator can help the investor to decide on stop loss and take profit as well.
 Fig 30

9.4 STOCHASTIC OSCILLATOR

This momentum Oscillator was created by George Lane in the late 1950s. The stochastic
oscillator presents the location of the closing price of a stock in relation to the high and low
range of the price of a stock over a period of time ,typically a 14 day period. He originally
designed the oscillator to follow the momentum of price but now its more popularly used to
identify the overbought and oversold conditions. The stochastic is scaled from 0 to 100.When
the stochastic lines are above 80 usually denoted by a red line ,then the market is said to be
overbought. When the lines are below 20 usually denoted by a blue line ,then the market is
said to be oversold. The overbought readings are not necessarily bearish , because this can
remain overbought during a strong uptrend. In a similar way, oversold readings are not always
bullish , this can remain oversold and remain oversold during a strong downtrend.

Closing levels that are consistently near the top of the range indicate accumulation of buying
pressure and those near the bottom of the range indicate distribution or selling pressure. The
key concept behind this indicator is that in an upward trending market , prices tend to close
near their high and during a downward trending market, prices tend to close near their
low.The stochastic oscillator is set at 14 periods by default ,which can be days ,weeks ,months
or an intraday timeframe. A 14%K would use the most recent close ,the highest high over the
last 14 periods and the lowest low over the last 14 periods .The %D is the 3 day moving
averages of %K. This line is plotted alongside %K to denote as a signal or trigger line. The below
graph is the candle stick chart of Nifty futures along with stochastic oscillator indicator.

Fig 31

9.5 PIVOT POINTS

The pivot point is a technical analysis indicator used to determine the overall trend of the
market over different time frames.We calculate the pivot point of a stock by taking the average
of the opening ,closing , high and low of the previous candle. On the subsequent day ,trading
above the pivot point is considered to indicate bullish sentiments and trading below the pivot
point indicates bearish sentiments. It helps the trader to find out the support and resistance
levels and also to plan for the stop loss and take profit points. The other types of pivot points
include the Woodie’s pivot point , classical or standard pivot point , Fibonacci pivot point and
camarilla pivot point.

The pivot points and the associated support and resistance levels are calculated by using the
last trading session’s open ,high, low and close.

The calculation for a pivot point are as follows:

Pivot point (PP) = (High +Low +Close )/3

The support and resistance levels are then calculated .

First level support and resistance:

First resistance (R1) =(2*PP)- Low

First support (S1)=(2* PP)-High

Second level of support and resistance:

Second resistance (R2) =PP +(High –Low)

Second Support (S2) =PP-(High –Low)

Third level of support and resistance:

Third resistance(R3)= High +2(PP-Low)

Third Support (S3) =Low -2(High-PP)

9.6 BOLLINGER BANDS

Bollinger Bands , a technical indicator developed by John Bollinger is used to measure the
volatility of the market. When the market is quiet ,the bands contract and when the market is
loud, the bands expand. These are mostly used to determine the overbought and oversold
levels, where a trader will short when the price reaches the top of the band and will execute a
long position when the price reaches the bottom of the band. The band automatically widens
with the increase in the volatility and it narrows as the volatility decreases. The investors use
the Bollinger bands to identify various signals including the W bottoms , M bottoms and to
determine the strength of the trend.
The Bollinger bands has three components : the middle line is the 20 day moving average of the
closing prices, an upper band is the +2 standard deviation of the middle line and the lower band
is the -2 standard deviation of the middle line. The middle band is a measure of the
intermediate term trend ,usually a simple moving average that serves as the base for the upper
band and lower band. The interval between the upper and lower bands and the middle band is
determined by volatility. The middle band is a simple moving average that is usually set at 20
periods. A simple moving average is used because the standard deviation formula also uses a
simple moving average.The outer bands are usually set 2 standard deviations above and below
the middle band.The below graph is the candle stick chart of Nifty futures along with Bollinger
bands indicator.

Fig 32

The formula can be simplified as follows :

Middle band =n- period moving average

Upper band =Middle band + (y *n-period standard deviation)

Lower band =Middle band- (y*n-period standard deviation )

Where: n= number of periods

Y=factor to apply to the standard deviation value (y=2)

W bottom signal
This was developed by Arthur Merril ,who identified 16 patterns with a basic W shape .A
WBottom forms in a downtrend and involves two reaction lows. The second low must be lower
than the first bottom ,but it has to be above the lower band. Second there has to be a bounce
towards the middle band .The next low formed must be lower than the initial one and it should
be above the lower band. Finally the the pattern shows a strong upward trend. Bolinger bands
are calculated on closing prices so signals should also be based on closing prices .

Fig 33

M tops signal
This signal was also part of Arthur Merril’s work that identified 16 patterns with a basic M
shape. M top pattern is similar to a double top. The highs of the pattern may not be always
equal .The first high can be higher or lower than the second high .This is the exact opposite of
W bottoms. At first a security creates a reaction high above the upper band , followed by a
pullback towards the middle band.Third ,the prices move above the prior high but fails to reach
the upper band.This is a warning sign for the investor .The inability of the second high to reach
the upper band shows the declining momentum and may lead to a trend reversal. The final
confirmation comes up with a support break or a bearish indicator signal.
 Fig 34

Walking the bands signal

When the pattern touches the upper band after the Bollinger band confirms a W –Bottom
would signal the start of an uptrend. The 20 day simple moving average line acts as a support .
The dip below the 20 days SMA provides buying opportunities to the investor. There would be
instances where pattern goes in a downtrend after an M top formation. The stock would not
be closing above the upper band rather would close below the lower band .Here he support
break and the initial close below the lower band signals a downtrend.
 Fig 35

10. LIMITATIONS
 • Futures are expensive and highly leveraged products that carries high risks , thus
investors/traders are not always active like stock market traders.

• Futures contracts carry definite expiration dates , thus whatever the established fixed
price be , it may appear less attractive when the expiry dates are near.

• Futures were mainly introduced for hedging purpose in the market , but it has been
used for speculation by retail investors ,thus leading to unnecessary volatility and price
movements in the market .

• Forex market provide the maximum leverage and are thus highly risky products. Thus
an highly leveraged bet in forex can lead to a huge loss.

• The Japanese candle sticks look different on every time frame. Thus it’s difficult to trust
them completely on different time frames.

• The candle sticks are a lagging indicator.

• Technical indicators may give mixed signals , if they are used in isolation. Thus its
always better to use a combination of indicators and patterns .

• Technical indicators are mostly based on probability, thus it’s not always necessary to
be correct even after a thorough analysis.

• A single trading strategy may not be work out in all situations in the market .The
strategies needs to be updated and revised as per the market.

• Investors can neither be completely reliable on candle sticks nor on technical

indicators.

INTRODUCTION OF 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 costs nothing (except margin requirement) to enter into a futures contracts, the
purchase of an option requires as up-front payment.

DEFINITION:
Option is a type of contract between two persons where one grants the other the right to buy a
specific asset at a specific price within a specific time period. Alternatively the contract may
grant the other person the right to sell a specific asset at a specific price within a specific time
 period. In order to have this right. The option buyer has to pay the seller of the option
premium. The assets on which option can be derived are stocks, commodities, indexes etc. If
the underlying asset is the financial asset, then the option are financial option like stock
options, currency options, index options etc, and if options like commodity option.

PROPERTIES OF OPTION:
Options have several unique properties that set them apart from other securities.
The following are the properties of option:
 Limited Loss
 High leverages potential
 Limited Life

PARTIES IN AN OPTION CONTRACT:

BUYER/HOLDER/OWNER OF AN OPTION:
The buyer of an option is one who by paying option premium buys the right but not
the obligation to exercise his option on seller/writer.

SELLER/WRITER OF AN OPTION:
The writer of the call /put options is the one who receives the option premium and is there by
obligated to sell/buy the asset if the buyer exercises on him

TYPES OF OPTIONS:
The options are classified into various types on the basis of various variables. The following
are the various types of options.

I. ON THE BASIS OF THE UNDERLYING ASSET:

On the basis of the underlying asset the option are divided into two types:

 INDEX OPTIONS:

These options have the index as the underlying. Some options are European while others are
American. Like index futures contract, index options contracts are also cash settled.

 STOCK OPTIONS:

Stock options are options on the 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

II. ON THE BASIS OF THE MARKET MOVEMENTS:

On the basis of the market movements the option are divided into two types. They are:
  CALL OPTION:

A call option is bought by an investor when he seems that the stock price moves upwards. A
call option gives the holder of the option the right but not the obligation to buy an asset by a
certain date for a certain price.

 PUT OPTION:

A put option is bought by an investor when he seems that the stock price moves
downwards. A put option gives the holder of the option right but not the obligation to sell an
asset by a certain date for a certain price.

III. ON THE BASIS OF EXERCISE OF OPTION:

On the basis of the exercised of the option, the options are classified into two
categories.

 AMERICAN OPTION:

American options are options that can be exercised at any time up to the expiration
date, most exchange-traded option are American.
 EUOROPEAN OPTION:

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.

FACTORS EFFECTING THE PRICE OF AN OPTION:

The following are the various factors that affect the price of an option they are:
 Stock price: The pay–off from a call option is a amount by which the stock price exceeds
the strike price. Call options therefore become more valuable as the stock price increases and
vice versa. The pay-off from a put option is the amount; by which the strike price exceeds the
stock price. Put options therefore become more valuable as the stock price increases and vice
versa.
 Strike price: In case of a call, as a strike price increases, the stock price has to make a larger
upward move for the option to go in-the-money. Therefore, for a call, as the strike price
increases option becomes less valuable and as strike price decreases, option become more
valuable.
 Time to expiration: Both put and call American options become more valuable as a time to
expiration increases.
 Volatility: The volatility of a stock price is measured of uncertain about future stock price
movements. As volatility increases, the chance that the stock will do very well or very poor
increases. The value of both calls and puts therefore increase as volatility increase.
 Risk-free interest rate: The put options prices decline as the risk-free rate increases where
as the prices of call always increase as the risk-free interest rate increases.
 Dividends: Dividends have the effect of reducing the stock price on the x-dividend rate.
This has a negative effect on the value of call options and a positive effect on the value of put
options.
DIFFERENCES BETWEEN FUTURES & OPTIONS:
FUTURES OPTIONS

1.Exchange traded, with Novation 1.Same in nature

2.Exchange defines the product 2.Same in nature
3.Price is zero, strike Price moves 3.Strike price is fixed, price moves
4.Price is zero 4.Price is always positive
5.Linear payoff 5.Nonlinear payoff
6.Both long & Short at risk 6.only short at risk

Table : 4.2
5.DATA ANALYSIS & INTERPRETATION:
The Objective of this analysis is to evaluate the profit/loss position futures and options. This
analysis is based on sample data taken of M/s. KOTAK STOCK BROCKING
LIMITED scrip. This analysis considered the May contract of kotak. The lot size of kotak
is 100, the time period of the analysis is, from 11-05-2012 to30-06-2012.
Table : 5.1

KOTAK STOCK FUTURES & OPTIONS

PRICE CALL OPTION PUT OPTION

DATES (2) (3) (4)

(1)
SPOT FUTURE 740 800 840 740 800 840

May/fri/11 742.00 738.85 48.45 25.35 14.00 47.50 0 0

May/sat/12 742.80 740.20 65.15 30.35 17.00 30.15 0 0
May/sun/13 TRADING HOLIDAY
May/mon/14 780.00 770.05 55.25 32.25 16.30 30.95 64.95 0
May /tue/15 785.00 822.95 94.00 51.80 31.90 4.80 30.55 0
May /wed/16 815.55 823.15 108.20 55.15 32.80 13.00 31.55 0
May /thu/17 848.00 855.70 0 75.80 48.50 7.65 20.10 44.65
May /fri/18 845.00 848.75 123.00 71.35 42.25 8.90 20.25 36.55
May/sat/19 776.55 774.55 0 32.60 19.05 26.3 53.75 72.75
May/sun/20 TRADING HOLIDAY
May/mon/21 767.70 712.30 38.55 16.95 8.60 60.00 101.0 0
May /tue/22 700.00 685.40 24.15 11.55 8.00 73.00 130.0 0
 May /wed/23 685.00 692.50 24.70 9.80 8.40 0 0 0
May/thu/24 690.00 696.85 21.55 9.05 0 0 0 0
May /fri/25 711.00 716.65 23.80 8.80 0 0 0 0
May /sat/26 722.00 724.45 22.75 8.00 0 0 0 0
May/sun/27 TRADING HOLIDAY
May/mon/28 707.05 704.05 15.95 6.70 0 0 0 0
May/tue/29 695.00 682.90 31.00 77.00 13.00 0 0 0
May/wed/30 697.00 660.65 3.50 1.05 0 105.5 0 0
May/thu/31 660.00 634.80 0.90 0.75 1.05 0 0 0
Jun/fri/01 640.10 637.10 0.55 0.20
0 0 0 0

Jun/sat/02 645.00 673.25 1.20 0.20 0 0 0 0

Jun/sun/03
TRADING HOLIDAY

Jun/mon/04 681.35 661.45 0.05 0.05 0.05 0 0 0

TABLE DETAILS:
 The first column explains TRADING DATE.

 Second Column (a) explains the SPOT MARKET PRICE in cash segment on that date of
Opening Balance of Equity Amount.

 Second column (b) explains the FUTURE MARKET PRICE in cash segment on that date of
Closing Balance on Future Market Amount.

 The Third column explains call Option premiums amounting 740, 800, 840.

 The Fourth column explains Put Option premiums amounting 740, 800, 840.

OBSERVATIONS & FINDINGS:

CALL OPTION:
 BUYERS PAY OFF:
As brought 1 lot of KOTAK that is 100, those who buy for 740, paid 48.45 premiums per
share.

Settlement price is 681.35

Spot price 681.35
Strike price 740.00
 Amount -58.65
Premium paid (-) 48.45
Net Loss -10.20 x 100 = -1020
Buyer Loss = Rs.1020 (Loss)
Because it is negative it is in the money contract, hence buyer will get more loss, incase spot
price decrease buyer loss also increase.

 SELLERS PAY OFF:

It is in the money for the buyer, so it is in out of the money for seller; hence his profit is also
increase.

Strike price 740.00

Spot price 681.35
Amount +58.65
Premium Received 48.45
Net profit 10.20 x 100 = +1020
Seller Profit = Rs.1020 (Net Amount)

Because it is positive it is out of the money, hence seller will get more profit, incase spot
price increase in below strike price, seller get loss in premium level
 OBSERVATIONS & FINDINGS:
PUT OPTION:
 BUYERS PAY OFF:
Those who have purchase put option at a strike price of 740, the premium payable is 47.50
On the expiry date the spot market price enclosed at 681.35

Strike price 740.00

Spot price 681.35
Net pay off 58.65 x 100 = 5865

Already, premium paid 48.45, so it can get profit is 5865

Because it is Positive, out of the money contract, hence buyer will get more profit, incase
spot price increase buyer get loss in premium level.

 SELLERS PAY OFF:

As seller is entitled only for premium so, if he is in profit and also seller has to borne total
profit.

Spot price 681.35

Strike price 740.00
Amount -58.65 x100 =-5865

Already premium received 48.45 so, it can get loss is 5865

Because it is negative, in the money contract, Hence seller gets more loss, incase spot price
increase in above strike price seller can get profit in premium level.

ANALYSIS OF FUTURE PRICES:

The Objective of this analysis is to evaluate the profit/loss position futures and options. This
analysis is based on sample data taken of M/s. KOTAK STOCK BROCKING
LIMITED scrip. This analysis considered the May contract of KOTAK. The lot size of
KOTAK is 100, the time period of the analysis is, from 11-05-2012 to 30-06-2012
Table : 5.2
DATE FUTURE PRICE

MAY/FRI/11 738.85
MAY/SAT/12 740.20
MAY/MON/14 770.05
MAY /TUE/15 822.95
MAY /WED/16 823.15
MAY /THU/17 855.70
MAY /FRI/18 848.75
MAY/SAT/19 774.55
MAY/MON/21 712.30
MAY /TUE/22 685.40
MAY /WED/23 692.50
MAY/THU/24 696.85
MAY /FRI/25 716.65
MAY /SAT/26 724.45
MAY/MON/28 704.05
MAY/TUE/29 682.90
MAY/WED/30 660.65
MAY/THU/31 634.80
JUN/FRI/01 637.10
JUN/SAT/02 673.25 Figure : 5.1
JUN/MON/04 661.45

FUTURE MARKET:

BUYER SELLER

11/05/2012(Buying) 738.85 738.85

04/06/2012(Cl., period) 681.35 681.35

Loss 57.00 Profit 57.00

Profit 100 x57.00=5700, Loss 100 x 57.00=5700

 Because buyer future price will decrease so, he can get loss. Seller future price also decrease
so, profit also increase, In case seller future will increase, and he can get loss.

The closing price of “Mahindra Satyam” formerly “Satyam Computer services”,at the
end of the contract period is 681.35 and this is considered as settlement price.

DATA OF KOTAK – THE FUTURES & OPTIONS OF THE MAY –

JUNE MONTH 2012:
Table : 5.3
DATE SPOT PRICE FUTURE PRICE

MAY/FRI/11 742.00 738.85

MAY/SAT/12 742.80 740.20
MAY/MON/14 780.00 770.05
MAY /TUE/15 785.00 822.95
MAY /WED/16 815.55 823.15
MAY /THU/17 848.00 855.70
MAY /FRI/18 845.00 848.75
MAY/SAT/19 776.55 774.55
MAY/MON/21 767.70 712.30
MAY /TUE/22 700.00 685.40
MAY /WED/23 685.00 692.50
MAY/THU/24 690.00 696.85
MAY /FRI/25 711.00 716.65
MAY /SAT/26 722.00 724.45
MAY/MON/28 707.05 704.05
MAY/TUE/29 695.00 682.90
MAY/WED/30 697.00 660.65
MAY/THU/31 660.00 634.80
JUN/FRI/01 640.10 637.10
JUN/SAT/02 645.00 673.25
JUN/MON/04 681.35 661.45

Figure : 5.2
6.CONCLUSIONS
OBSERVATIONS AND FINDINGS:
 The future price of M/S KOTAK STOCK moving along with the market price.

 If the buy price of the future is less than the settlement price, than the buyer gets profit on
futures.

 If the selling price of the future is less than the settlement price, than the seller incur losses.
 SUGGESTIONS:
 In bullish market the call option writer incurs more losses so the investor is suggested to go
for a call option to hold, where as the put option holder suffers in a bullish market, so he is
suggested to write a put option.

 In bearish market the call option holder will incur more losses so the investor is suggested to
go for a call option to write, where as the put option writer will get more losses, so he is
suggested to hold a put option.

 In the above analysis the market price of M/S.KOTAK is having low volatility, so the call
option writers enjoy more profits to holders.

 The derivative market is newly started in India and it is not known by every investor, so
SEBI has to take steps to create awareness among the investors about the derivative segment.

 In order to increase the derivatives 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.

CONCLUSIONS:
 Derivatives market is an innovation to cash market. Approximately its daily turnover reaches
to the equal stage of cash market. The average daily turnover of the NSE derivative segments

 In cash market the profit/loss of the investor depends on the market price of the underlying
asset. The investor may incur huge profits or he may incur huge loss. But in derivatives
segment the investor enjoys huge profits with limited downside.

 In cash market the investor has to pay the total money, but in derivatives the investor has to
pay premiums or margins, which are some percentage of total money.

 Derivatives are mostly used for hedging purpose.

 In derivative segment the profit/loss of the option writer is purely depend on the fluctuations
of the underlying asset.

BIBLIOGRAPHY:
 BOOKS:
 Derivatives Dealers Module Work book–NCFM
 Financial Markets and Services–GORDAN and NATRAJAN
 Financial Management – PRASANNA CHANDRA

 JOURNALS:
 The journal of derivatives.
 International journal of financial markets & derivatives.

 NEWS PAPERS:
 Economic times
 The Hindu
 Business Standard

 MAGAZINES:
 Business Today
 Business World
 Business India

 WEBSITES:
 www.derivativesindia.com
 www.indianinfoline.com
 www.nseindia.com
 www.bseindia.com
 www.sebi.gov.in
 www.google.com
+