Empirical Analysis of Equity Derivative

Empirical analysis of equity & derivatives
EMPIRICAL ANALYSIS OF EQUITY & DERIVATIVES
A Project Report Submitted In Partial

Fulfillment
Of Post Graduate Diploma in Management
(PGDM)
To
TIMSR
By
RAJ PANDYA
Batch 2010-11
Under the Guidance of

Prof. Dr. GITIKA MAYANK
THAKUR INSTITUTE OF MANAGEMENT STUDIES

AND RESEARCH
KANDIVILI
MUMBAI
CERTIFICATE
This is to certify that the study presented by Raj Pandya to Thakur
Institute of Management Studies and Research in part completion of Post
Graduate Diploma in Management under Empirical analysis of equity and
derivatives has been done under my guidance in the year 2009 - 2011
The Project is in the nature of original work that has not so far been
submitted for any other course in this institute or any other institute.
Reference of work and relative sources of information have been given at
the end of the project
Signature of the Candidate
(Raj Pandya)
Forwarded through the Research Guide
Signature of the Guide
(Prof. Dr. Gitika Mayank)
ACKNOWLEDGEMENT
The success of my project was not only with my efforts but also with
interest, guidance and help offered to me by others.
It gives me great pleasure to express my gratitude towards all the
individuals who have directly or indirectly helped me in completing this
project.
I wish to express my sincere thanks to our Director Dr. Mrinalini
Kohojkar and my project guide Prof. Dr. Gitika Mayank for providing
me valuable guidance & inputs which helped me to complete this project
in true sense.
I would also like to express my thanks to my colleagues for their constant
help and guidance throughout the project.
Also, not forgetting the college library facilities and computer lab facilities
without whose help gathering the relevant information would not have been
possible.
Executive Summary
The project is about the empirical analysis of equity and derivative. It
gives the knowledge of market position of the company. I studied as to
how this company proves to an option for the investors, by studying the
performance of investing in equity & derivative for few months
considering their analysis. I selected area of empirical analysis of equity &
derivative, which attract different kinds of investors to invest in equity
derivative and to face high risk and get high returns. I have applied some
option strategies on the live market. The major findings of the project are
to overview of the comparison between equity cash segment and equity
derivative segment . The methodology of the project here is to analyze
the Equity & Derivative performance based on fundamental and option
strategies.
The methodology of the project here is to analyze the investment
opportunities available for those investors & study the returns & risk
involved in various investment opportunities and also study of investment
management & risk management. So for that we have to study & analyze
the performance of Equity & Derivative in the market. We know that there
is a high risk, high return in equity but in a long time only. While in
derivative there is a high risk, high return in the short term, because
derivative contract is for short time for 1/2/3 months only. So this project
included different types of returns, margin & risk involved in equity, and
types, need, use & margin involved in the derivatives market and also
participants & terms use in derivative market.
Objective of the study

Any investors vision is a long term investment and short term investment
and gets high returns by bearing high risk. For that objective need to be
climbed successfully an so objectives of this project are,
1) To find the RIGHT SCRIPT to buy and sell at the RIGHT TIME
2) To get good return.
3) To know how derivatives can be use for hedging.
4) To know the outcome of Equity and Derivative.
5) How to apply derivative option strategies.
METHODOLOGY OF THE PROJECT

Defining objective wont suffice unless and until a proper methodology is
to achieve the objectives.
1) Analyzing and observing the investment opportunities.
2) Analyzing the performance of Equity and Derivative market with the
help of NAV, EPS, P/E ratio etc.
INDEX
Sr. No
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Topic
Introduction
Equity
Benefits of equity
Risk in equity investment
Selection of shares
Lesson to be learn
Types of cash margin
Derivative
Types of derivatives
Option strategies
Types of traders in derivative market
Types of future & option margin
Comparative analysis
Conclusion
References
Page No.
1
3
4
6
8
10
14
17
19
29
34
36
39
44
45
Introduction
Background of the study:
The oldest stock exchange in Asia (established in 1875) and the first in the
country to be granted permanent recognition under the Securities
Contract Regulation Act, 1956, Bombay Stock Exchange Limited (BSE) has
had an interesting rise to prominence over the past 133 years. A lot has
changed since 1875 when 318 persons became members of what today is
called Bombay Stock Exchange Limited paying a princely amount of Re
1. In 2002, the name "The Stock Exchange, Mumbai" was changed to
Bombay Stock Exchange. Subsequently on August 19, 2005, the exchange
turned into a corporate entity from an Association of Persons (AoP) and
renamed as Bombay Stock Exchange Limited. BSE, which had introduced
securities trading in India, replaced its open outcry system of trading in
1995, with the totally automated trading through the BSE Online trading
(BOLT) system. The BOLT network was expanded nationwide in 1997.
Since then, the stock market in the country has passed through both good
and bad periods. The journey in the 20th century has not been an easy
one. Till the decade of eighties, there was no measure or scale that could
precisely measure the various ups and downs in the Indian stock market.
Bombay stock Exchange Limited (BSE) in 1986 came out with a stock
Index that subsequently became the barometer of the Indian Stock
Market.
SENSEX first compiled in 1986 was calculated on a Market Capitalization
Weighted methodology of 30 component stocks representing a sample of
large, well established and financially sound companies. The base year of
SENSEX is 1978-79. The index is widely reported in both domestic and
international markets through prints as well as electronic media.
SENSEX is not only scientifically designed but also based on globally
accepted construction and review methodology. From September 2003,
the SENSEX is calculated on a free-float market capitalization
methodology.
The
free-float
Market
Capitalization-Weighted
methodology is a
widely followed index construction methodology on which majority of
global equity benchmarks are based.
The growth of equity markets in India has been phenomenal in the decade
gone by Right from early nineties the stock market witnessed heightened
activity in terms of various bull and bear runs. The SENSEX captured all
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these happenings in the most judicial manner. One can identify the booms
and bust of the Indian equity market through SENSEX.
The Exchange also disseminates the Price-Earnings Ratio, the Price to
Book Value Ratio and the Dividend Yield Percentage on day-to-day basis of
all its major indices.
The value of all BSE indices are every 15 seconds during the market hours
and displayed through the BOLT system. BSE website and news wire
agencies.
All BSE-Indices are reviewed periodically by the Index Committee of the
Exchange. The Committee frames the broad policy guidelines for the
development and maintenance of all BSE indices.
Department of BSE Indices of the exchange carries out the day to day
maintenance of all indices and conducts research on development of new
indices. Institutional investors, money managers and small investors all
refer to the Sensex for their specific purposes The Sensex is in effect the
substitute for the Indian stock markets. The country's first derivative
product i.e. Index-Futures was launched on SENSEX.
Equity
Total equity capital of a company is divided into equal units of small
denominations, each called a share.
It is a stock or any other security representing an ownership
interest.
It proves the ownership interest of stock holders in a company.
For example:
In a company the total equity capital of Rs 2, 00, 00,000 is divided into 20,
00,000 units of Rs 10 each. Each such unit of Rs 10 is called a Share.
Thus, the company then is said to have 20, 00,000 equity shares of Rs 10
each. The holders of such shares are members of the company and have
voting rights.
Benefits from Equity

The benefits distributed by the company to its shareholders can be: 1)
Monetary Benefits and 2) Non Monetary Benefits.
1. Monetary Benefits:
A. Dividend: An equity shareholder has a right on the profits generated
by the company. Profits are distributed in part or in full in the form of
dividends. Dividend is an earning on the investment made in shares, just
like interest in case of bonds or debentures. A company can issue dividend
in two forms: a) Interim Dividend and b) Final Dividend. While final
dividend is distributed only after closing of financial year; companies at
times declare an interim dividend during a financial year. Hence if X Ltd.
earns a profit of Rs 40 crore and decides to distribute Rs 2 to each
shareholder, a holding of 200 shares of X Ltd. would entitle you to Rs 400
as dividend. This is a return that you shall earn as a result of the
investment made by you by subscribing to the shares of X Ltd.
B. Capital Appreciation: A shareholder also benefits from capital
appreciation. Simply put, this means an increase in the value of the
company usually reflected in its share price. Companies generally do not
distribute all their profits as dividend. As the companies grow, profits are
re-invested in the business. This means an increase in net worth, which
results in appreciation in the value of shares. Hence, if you purchase 200
shares of X Ltd at Rs 20 per share and hold the same for two years, after
which the value of each share is Rs 35. This means that your capital has
appreciated by Rs 3000.
2. Non-Monetary Benefits: Apart from dividends and capital
appreciation, investments in shares also fetch some type of non-monetary
benefits to a shareholder. Bonuses and rights issues are two such
noticeable benefits.
A. Bonus: An issue of bonus shares is the distribution free of cost to the
shareholders usually made when a company capitalizes on profits made
over a period of time. Rather than paying dividends, companies give
additional shares in a pre-defined ratio. Prima facie, it does not affect the
wealth of shareholders. However, in practice, bonuses carry certain latent
advantages such as tax benefits, better future growth potential, and an
increase in the floating stock of the company, etc. Hence if X Ltd decides
to issue bonus shares in a ration of 1:1, every existing shareholder of X
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Ltd would receive one additional share free for each share held by him. Of
course, taking the bonus into account, the share price would also ideally
fall by 50 percent post bonus. However, depending upon market
expectations, the share price may rise or fall on the bonus announcement.
B. Rights Issue: A rights issue involves selling of ordinary shares to the

existing
shareholders of the company. A company wishing to increase its
subscribed capital by allotment of further shares should first offer them to
its existing shareholders. The benefit of a rights issue is that existing
shareholders maintain control of the company. Also, this results in an
expanded capital base, after which the company is able to perform better.
This gets reflected in the appreciation of share value.
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Risks In equity investment:

Although an equity investment is the most rewarding in terms of returns
generated, certain risks are essential to understand before venturing into
the world of equity.
Market/ Economy Risk.
Industry Risk.
Management Risk.
Business Risk.
Financial Risk
Exchange Rate Risk.
Inflation Risk.
Interest Rate Risk.
How to overcome risks:

Most risks associated with investments in shares can be reduced by using
the tool of diversification. Purchasing shares of different companies and
creating a diversified portfolio has proven to be one of the most reliable
tools of risk reduction.
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The process of Diversification:

When you hold shares in a single company, you run the risk of a large
magnitude. As your portfolio expands to include shares of more
companies, the company specific risk reduces. The benefits of creating a
well diversified portfolio can be gauged from the fact that as you add
more shares to your portfolio, the weightage of each companys share
gets reduced. Hence any adverse event related to any one company
would not expose you to immense risk. The same logic can be extended to
a sector or an industry. In fact, diversifying across sectors and industries
reaps the real benefits of diversification. Sector specific risks get
minimised when shares of other sectors are added to the portfolio. This is
because a recession or a downtrend is not seen in all sectors together at
the same time.
However all risks cannot be reduced:

Though it is possible to reduce risk, the process of equity investing itself
comes with certain inherent risks, which cannot be reduced by strategies
such as diversification. These risks are called systematic risk as they arise
from the system, such as interest rate risk and inflation risk. As these risks
cannot be diversified, theoretically, investors are rewarded for taking
systematic risks for equity investment.
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Selection of Shares
Proper selections of shares are of two types:
1. Fundamental analysis:
It involves in depth study and analysis of the prospective company whose
shares we want to buy, the industry it operates in and the overall market
scenario. It can be done by reading and assessing the companys annual
reports, research reports published by equity research houses, research
analysis published by the media and discussions with the companys
management or the other experienced investors.
2. Technical analysis:
It involves studying the prices movement of the stock over an extended
period of time in the past to judge the trend of the future price movement.
It can be done by software programs, which generate stock prices charts
indicating upward. Downward and sideways movements of the stock price
over the stipulated time period.
When to buy & sell shares:

With high volatility prevailing in the market, major price fluctuations in
equities are not uncommon. Therefore, apart from ascertaining which
stock to buy or sell, it becomes equally important to consider when to
buy or sell. Any investor should be aware of the fact where all the investor
is following i.e., Buy Low. Sell High.
That means we should buy stocks at a low price and sell them at a high
price.
When to buy
Three ways by which we can figure that out what it is about this stock that
makes it hot.
14

1. Earnings per Share (EPS): How well the company is doing
EPS is the total earning or profits made by company (during a given period
of time) calculated on per share basis. It aims to give an exact evaluation
of the returns that the company can deliver.
Example:
Company XYZ Ltd. Capital: Rs 100 crore (Rs 1 billion).
Capital is the amount the owner has in the business. As the business
grows and makes profits, it adds to its capital. This capital is subdivided
into shares (or stocks). The capital is divided into 100 million shares of Rs
10 each.
Net Profit in 2003-04: Rs 20 crore (Rs 200 million).
EPS is the net profit divided by the total number of shares.
EPS = net profit/ number of shares
EPS = Rs 20 crore (Rs 200 million)/ 10 crore (100 million) shares = Rs 2
per share
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Lesson to be learnt
If a company's EPS has grown over the years, it means the company is
doing well, and the price of the share will go up. If the EPS declines, that's
a bad sign, and the stock price falls.
Companies are required to publish their quarterly results. Keep an eye out
for these results; check for the trend in their EPS.
Price earnings ratio (PE ratio): How other investors view this share
An indicator of how highly a share is valued in the market. It arrived at by
dividing the closing price of a share on a particular day by EPS. The ratio
tends to be high in the case of highly rated shares. The average PE ratio
for companies in an industry group is often given in investment journal.
Two stocks may have the same EPS. But they may have different market
prices. That's because, for some reason, the market places a greater value
on that stock. PE ratio is the market price of the stock divided by its EPS.
PE = market price/ EPS
Lets take an example of two companies.
Company XYZ Ltd
Market price = Rs 100
EPS = Rs 2
PE ratio = 100/ 2 = 50
Company ABC Ltd

Market price = Rs 200
EPS = Rs 2
PE ratio = 200/ 2 = 100
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In the above cases, both companies have the same EPS. But because their
market price is different, the PE ratio is different.
In the case of EPS, it is not so much a high or low EPS that matters as the
growth in the EPS. The company's PE reflects investors' expectations of
future growth in the EPS. A high PE company is one where investors have
hopes that earnings will rise, which is why they buy the share.
Forward PE: Looking ahead
The stock market is not nostalgic. It is forward looking. For instance, it
sometimes happens that a sick company, that has made losses for several
years, gets a rehabilitation package from its bank and a new CEO. As a
consequence, the company's stock shoots up. Because investors think the
company will do better in the future because of the package and new
leadership, and its earnings will go up. And we think it is a good time to
buy the shares of the company now. Suddenly, the demand for the shares
has gone up. Because stock prices are based on expectations of future
earnings, analysts usually estimate the future earnings per share of a
company. This is known as the forward PE. Forward PE is the current
market price divided by the estimated EPS, usually for the next financial
year.
Forward PE = Current market price/ estimate EPS for the next

financial year.
To illustrate what we have been talking about, let's take the example of
ABC LTD.
Trailing 12-month EPS = Rs 56.82 (EPS of the last four quarters)
Closing price on January 6 = Rs 2043.15
PE = Price/EPS = 2043.15/ 56.82 = 35.95
Estimated EPS for 2009-10 = Rs 67
Estimated EPS for 2010-11 = Rs 90
these figures are according to brokers' consensus estimates.
Forward PE = current market price/ estimated EPS for next financial year
Forward PE for 2009-10 = 2043.15/ 67 = 30.49
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Forward PE for 2010-11 = 2043.15/ 90 = 22.70
With an EPS growth of over 30%, a forward PE of 22.7 is not high,
indicating that there is scope to be optimistic about the stock's price.
Sometimes, investors look out for a low PE stock, expecting that its price
will rise in the future. But sometimes, low PE stocks may remain low PE
stocks for ages, because the market doesn't fancy them.
Keep tab on the business news to check out the company's prospects in
the future
When to sell
Stock Reaches Fair Value or Target Price
This is the easiest part of selling. We should sell when a stock reaches its
fair value. It is the main reason why we chose to buy it on the first place.
The target price can be computed by assessing the companys estimated
financial performance over the next 3 to 5 years, computing its EPS and
using an acceptable P/E ratio to compute the future market price. Based
on this future estimated price and our required return on our investment,
compute our target price.
When the prices reaches Stop loss

It is advisable to always consider the possibility of a loss before making
our investment. We should decide how much loss we are willing to book in
the stock. The lower price i.e., the price at which we are willing curtail our
loss, is called Stop Loss.
Need the money

The generally happens due to improper planning. However, things
happen. Even the most carefully planned strategy may not work.
Catastrophic events may force investors to sell an investment if his
household is affected by it.
The book is unclean
18

When management left their post abruptly or when the SEBI conduct a
criminal investigation on a company, it may be time to sell. Our
assumption may be inaccurate as a lot of fair value calculation is based on
the company's balance sheet, cash flow or other financial statement
published by management.
Takeover news
When one of your stock holding is getting bought by other companies, it
may be time to sell. Sure, you might like the acquiring company but you
still need to figure out the fair value of the common stock of the acquiring
company. If the acquiring company is overvalued, then it is best to sell.
Other Investment Opportunity

Let us consider we bought stock A and it has risen to 10% below its fair
value. Meanwhile, we noticed that stock B fallen to below 50% of our
calculated fair value. This is an easy decision. We will sell our stock A and
buy stock B. Our goal as an investor is to maximize our investment return.
Sacrificing a 10% of return in order to earn a 50% return is a sensible way
to do that.
Inaccurate Fair Value Calculation

As investors, we sometimes made errors in our fair value calculation.
There are factors that we might not take into accounts when researching a
particular company. For example, satyam scandal.
New Competitors with Better Products

When new competitors sprung up, the company that you hold might have
to spend more money in order to fend off competition. Recent example
includes the emergence of pay-per click advertising by Google. Any
advertising business such as newspapers or cable network, this new
product by Google might hurt profit margins and eventually the fair value
of the stock.
Not having a valid reason to Buy

19

When we don't know why we bought a particular stock, we won't know
how much our potential return is or when we should sell it. This is the
easiest way of losing money. When we have no valid reason to buy, we
should sell immediately.
Types of Cash market margin

1. Value at Risk (VaR) margin.
2. Extreme loss margin
3. Mark to market Margin
1. Value at Risk (VaR) margin :

VaR Margin is at the heart of margining system for the cash market
segment. VaR is a technique used to estimate the probability of loss of
value of an asset or group of assets (for example a share or a portfolio of
a few shares), based on the statistical analysis of historical price trends
and volatilities.
A VaR statistic has three components: a time period, a confidence level
and a loss amount (or loss percentage). Keep these three parts in mind as
we give some examples of variations of the question that VaR answers:
With 99% confidence, what is the maximum value that an asset or
portfolio may lose over the next day?
Example:
Suppose shares of a company bought by an investor. Its market value
today is Rs.50 lakhs but its market value tomorrow is obviously not known.
An investor holding these shares may, based on VaR methodology, say
that 1-day VaR is Rs.4 lakhs at 99% confidence level. This implies that
under normal trading conditions the investor can, with 99% confidence,
say that the value of the shares would not go down by more than Rs.4
lakhs within next 1-day.
20

In the stock exchange scenario, a VaR Margin is a margin intended to
cover the largest loss (in %) that may be faced by an investor for his / her
shares (both purchases and sales) on a single day with a 99% confidence
level. The VaR margin is collected on an upfront basis (at the time of
trade).
How is VaR margin calculated?

VaR is computed using exponentially weighted moving average (EWMA)
methodology. Based on statistical analysis, 94% weight is given to
volatility on T-1 day and 6% weight is given to T day returns.
To compute, volatility for January 1, 2008, first we need to compute days

return for Jan 1, 2009 by using LN (close price on Jan 1, 2009 / close price
on Dec 31, 2008).
Take volatility computed as on December 31, 2008.
Use the following formula to calculate volatility for January 1, 2009:
Square root of [0.94*(Dec 31, 2008 volatility)*(Dec 31, 2008 volatility)+
0.06*(January 1, 2009 LN return)*(January 1, 2009 LN return)]
Example:
Share of ABC Ltd
Volatility on December 31, 2008 = 0.0314
Closing price on December 31, 2008 = Rs. 360 Closing price on January 1,
2009 = Rs. 330
January 1, 2009 volatility =
Square root of [(0.94*(0.0314)*(0.0314) + 0.06 (0.08701)* (0.08701)] =
0.037 or 3.7%
How is the Extreme Loss Margin computed?
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The extreme loss margin aims at covering the losses that could occur
outside the coverage of VaR margins.
The Extreme loss margin for any stock is higher of 1.5 times the standard
deviation of daily LN returns of the stock price in the last six months or 5%
of the value of the position.
This margin rate is fixed at the beginning of every month, by taking the
price data on a rolling basis for the past six months.
Example:
In the Example given at question 10, the VaR margin rate for shares of
ABC Ltd. was 13%. Suppose the 1.5 times standard deviation of daily LN
returns is 3.1%. Then 5% (which is higher than 3.1%) will be taken as the
Extreme Loss margin rate.
Therefore, the total margin on the security would be 18% (13% VaR
Margin + 5% Extreme Loss Margin). As such, total margin payable (VaR
margin + extreme loss margin) on a trade of Rs.10 lakhs would be 1,
80,000/
How is Mark-to-Market (MTM) margin computed?

MTM is calculated at the end of the day on all open positions by
comparing transaction price with the closing price of the share for the day.
Example:
A buyer purchased 1000 shares @ Rs.100/-at 11 am on January 1, 2008. If
close price of the shares on that day happens to be Rs.75/-, then the
buyer faces a notional loss of Rs.25, 000/ -on his buy position. In technical
terms this loss is called as MTM loss and is payable by January 2, 2008
(that is next day of the trade) before the trading begins.
In case price of the share falls further by the end of January 2, 2008 to Rs.
70/-, then buy position would show a further loss of Rs.5,000/-. This MTM
loss is payable.
In case, on a given day, buy and sell quantity in a share are equal, that is
net quantity position is zero, but there could still be a notional loss / gain
22

(due to difference between the buy and sell values), such notional loss
also is considered for calculating the MTM payable.
MTM Profit/Loss = [(Total Buy Qty X Close price)] -Total Buy Value] -[Total
Sale Value (Total Sale Qty X Close price)]
Derivatives
Derivative is a product whose value is derived from the value of one or
more basic variables, called bases (underlying asset, index, or reference
rate), in a contractual manner.
The underlying asset can be equity, forex, commodity or any other asset.
For example, wheat farmers may wish to sell their harvest at a future date
to eliminate the risk of a change in prices by that date. Such a transaction
is an example of a derivative. The price of this derivative is driven by the
spot price of wheat which is the "underlying".
In the Indian context the Securities Contracts (Regulation) Act, 1956

(SCRA) defines
"derivative" to include-
1. A security derived from a debt instrument, share, loan whether secured

or unsecured, risk instrument or contract for differences or any other form
of security.
2. A contract which derives its value from the prices, or index of prices, of
underlying securities.
Derivatives are securities under the SC(R)A and hence the trading of
derivatives is governed by the regulatory framework under the SC(R)A.
23
Factors driving the growth of derivatives
Over the last three decades, the derivatives market has seen a
phenomenal growth. A large variety of derivative contracts have been
launched at exchanges across the world. Some of the factors driving the
growth of financial derivatives are:
1. Increased volatility in asset prices in financial markets,
2. Increased integration
international markets,
of
national
financial
markets
with
the
3. Marked improvement in communication facilities and sharp decline in

their costs,
4. Development of more sophisticated risk management tools, providing
economic agents a wider choice of risk management strategies, and
5. Innovations in the derivatives markets, which optimally combine the
risks and returns over a large number of financial assets leading to higher
returns, reduced risk as well as transactions costs as compared to
individual financial assets.
24
Types of derivatives
1. Forward Contract:
A forward contract is an agreement to buy or sell an asset on a specified
date for a specified price. One of the parties to the contract assumes a
long position and agrees to buy the underlying asset on a certain specified
future date for a certain specified price. The other party assumes a short
position and agrees to sell the asset on the same date for the same price.
Other contract details like delivery date, price and quantity are negotiated
bilaterally by the parties to the contract. The forward contracts are
normally traded outside the exchanges.
The salient features of forward contracts are:

They are bilateral contracts and hence exposed to counter-party risk.
Each contract is custom designed, and hence is unique in terms of
contract size, expiration date and the asset type and quality.
The contract price is generally not available in public domain.
25

On the expiration date, the contract has to be settled by delivery of the
asset.
If the party wishes to reverse the contract, it has to compulsorily go to
the same counter-party, which often results in high prices being charged.
Limitations of Forward Contract
Forward markets world-wide are afflicted by several problems:

Lack of centralization of trading,
Illiquidity, and
Counterparty risk
In the first two of these, the basic problem is that of too much flexibility
and generality. The forward market is like a real estate market in that any
two consenting adults can form contracts against each other. This often
makes them design terms of the deal which are very convenient in that
specific situation, but makes the contracts non-tradable.
Counterparty risk arises from the possibility of default by any one party to
the transaction. When one of the two sides to the transaction declares
bankruptcy, the other suffers. Even when forward markets trade
standardized contracts, and hence avoid the problem of illiquidity, still the
counterparty risk remains a very serious issue.
2. Future Contracts:
Futures markets were designed to solve the problems that exist in forward
markets. A futures contract is an agreement between two parties to buy or
sell an asset at a certain time in the future at a certain price. But unlike
forward contracts, the futures contracts are standardized and exchange
traded. To facilitate liquidity in the futures contracts, the exchange
specifies certain standard features of the contract. It is a standardized
26

contract with standard underlying instrument, a standard quantity and
quality of the underlying instrument that can be delivered, (or which can
be used for reference purposes in settlement) and a standard timing of
such settlement.
A futures contract may be offset prior to maturity by entering into an
equal and opposite transaction. More than 99% of futures transactions are
offset this way.
The standardized items in a futures contract are:

Quantity of the underlying
Quality of the underlying
The date and the month of delivery
The units of price quotation and minimum price change
Location of settlement
Payof
The payoff from a long position in a forward contract is

P = S - X, where S is a spot price of the security at time of contract
maturity, X is the delivery price.
27

Similarly, the payoff from a short position is
P = X - S.
For example, let's say the current price of the stock is $80.00 and we
entered in forward contract to buy this stock in 3 months time for $81.00
(that means we hope that price will not fall lower than $81.00). If after
three months price is more than $81.00, let's say $83.00, than we can buy
the same stock for $81.00 (as stated by forward contract) and after
reselling it on the market our payoff will be
P = $83.00 - $81.00 = $2.00
If at forward maturity the stock price falls to $78.00, than our loss will be
P = $81.00 - $78.00 = $3.00
The graphs above illustrate the forward contract payoff patterns for long
and short positions.
Distinction between futures and forwards
Future terminology
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the
futures market.
Contract cycle: The period over which a contract trades. The index
futures contracts on the NSE have one- month, two-month and three
months expiry cycles which expire on the last Thursday of the month.
Thus a January expiration contract expires on the last Thursday of January
and a February expiration contract ceases trading on the last Thursday of
February. On the Friday following the last Thursday, a new contract having
a three- month expiry is introduced for trading.
28

Expiry date: It is the date specified in the futures contract. This is the
last day on which the contract will be traded, at the end of which it will
cease to exist.
Contract size: The amount of asset that has to be delivered less than
one contract. Also called as lot size.
Basis: In the context of financial futures, basis can be defined as the
futures price minus the spot price. There will be a different basis for each
delivery month for each contract. In a normal market, basis will be
positive. This reflects that futures prices normally exceed spot prices.
Cost of carry: The relationship between futures prices and spot prices
can be summarized in terms of what is known as the cost of carry. This
measures the storage cost plus the interest that is paid to finance the
asset less the income earned on the asset.
Initial margin: The amount that must be deposited in the margin
account at the time a futures contract is first entered into is known as
initial margin.
Marking-to-market: In the futures market, at the end of each trading

day, the margin account is adjusted to reflect the investor's gain or loss
depending upon the futures closing price. This is called marking-tomarket.
Maintenance margin: This is somewhat lower than the initial margin.
This is set to ensure that the balance in the margin account never
becomes negative. If the balance in the margin account falls below the
maintenance margin, the investor receives a margin call and is expected
to top up the margin account to the initial margin level before trading
commences on the next day.
3. Option Contracts
An option is a contract written by a seller that conveys to the buyer the
right but not the obligation to buy (in the case of a call option) or to
sell (in the case of a put option) particular asset, at a particular price
29

(Strike price / Exercise price) in future. In return for granting the option,
the seller collects a payment (the premium) from the buyer. Exchange
traded options form an important class of options which have
standardized contract futures and trade on public exchanges, facilitating
trading among large number of investors. Theyprovide settlement
guarantee by the Clearing Corporation thereby reducing counterpartyrisk.
Options can be used for hedging, taking a view on the future direction of
the market, for arbitrage or for implementing strategies which can help in
generating income for investors under various market conditions.
Option Terminology
Index options: These options have the index as the underlying. Some
options are European while others are American. Like index futures
contracts, index options contracts are also cash settled.
Stock options: Stock options are options on individual stoc ks. Options
currently trade on over 500 stocks in the United States. A contract gives
the holder the right to buy or sell shares at the specified price.
Buyer of an option: The buyer of an option is the one who by paying the
option premium buys the right but not the obligation to exercise his option
on the seller/writer.
Writer of an option: The writer of a call/put option is the one who
receives the option premium and is thereby obliged to sell/buy the asset if
the buyer exercises on him.
Option price/premium: Option price is the price which the option buyer
pays to the option seller. It is also referred to as the option premium.
Expiration date: The date specified in the options contract is known as
the expiration date, the exercise date, the strike date or the maturity.
Strike price: The price specified in the options contract is known as the
strike price or the exercise price.
American options: American options are options that can be exercised
at any time upto the expiration date. Most exchange-traded options are
American.
30

European options: European options are options that can be exercised
only on the expiration date itself. European options are easier to analyze
than American options, and properties of an American option are
frequently deduced from those of its European counterpart.
In-the-money option: An in-the-money (ITM) option is an option that
would lead to a positive cash flow to the holder if it were exercised
immediately. A call option on the index is said to be in-the-money when
the current index stands at a level higher than the strike price (i.e. spot
price >strike price). If the index is much higher than the strike price, the
call is said to be deep ITM. In the case of a put, the put is ITM if the index
is below the strike price.
At-the-money option: An at-the-money (ATM) option is an option that
would lead to zero cash flow if it were exercised immediately. An option on
the index is at-the-money when the current index equals the strike price
(i.e. spot price = strike price).
Out-of-the-money option: An out-of-the-money (OTM) option is an
option that would lead to a negative cash flow if it were exercised
immediately. A call option on the index is out-of-the money when the
current index stands at a level which is less than the strike price (i.e. spot
price < strike price). If the index is much lower than the strike price, the
call is said to be deep OTM. In the case of a put, the put is OTM if the
index is above the strike price.
Intrinsic value of an option: The option premium can be broken down
into two components intrinsic value and time value. The intrinsic value of
a call is the amount the option is ITM, if it is ITM. If the call is OTM, its
intrinsic value is zero. Putting it another way, the intrinsic value of a call is
Max[0, (St K)] which means the intrinsic value of a call is the greater of
0 or (St K). Similarly, the intrinsic value of a put is Max[0, K St],i.e.
the greater of 0 or (K St). K is the strike price and St is the spot price.
Time value of an option: The time value of an option is the difference
between its premium and its intrinsic value. Both calls and puts have time
value. An option that is OTM or ATM has only time value. Usually, the
maximum time value exists when the option is ATM. The longer the time
to expiration, the greater is an option's time value, all else equal. At
expiration, an option should have no time value.
There are two basic types of options, call options and put options.
31

Call option: A call option gives the holder the right but not the obligation
to buy an asset by a certain date for a certain price.
i) Long a call:- person buys the right (a contract) to buy an asset at a
certain price. We feel that the price in the future will exceed the strike
price. This is a bullish position.
ii) Short a call:- person sells the right ( a contract) to someone that allows
them to buy to buy an asset at a certain price. The writer feels that asset
will devaluate over the time period of the contract. This person is bearish
on that asset.
Put option: A put option gives the holder the right but not the obligation
to sell an asset by a certain date for a certain price.
i) Long a put:- Buy the right to sell an asset at a pre-determined price. We
feel that the asset will devalue over the time of the contract. Therefore we
can sell the asset at a higher price than is the current market value. This
is a bearish position.
ii) Short a put:- sell the right to someone else. This will allow them to sell
the asset at a specific price. We feel the price will go down and we do not.
This is a bullish position.
Profit / payof in Option

The payoff to a derivative portfolio is the market value of the
portfolio at expiration. (Also gross payoff).
The profit on a derivative portfolio is the payoff less the cost of
acquisition or assembling the portfolio. (Net profit).
We will be looking
combinations.
at
a number
of
option strategies
and
The (gross) payoff is the value (positive or negative) of the option or

portfolio at maturity.
The payoff does not include the initial cost (or the initial cash inflow)
at the time the was set up.
Net profit= (gross) Payoff- cost of buying options or other
securities+ premium received for selling options or other securities.
32
If S is a final price of the option underlying security, X is a strike price and

OP is an option price,
33

than the profit is
Long Call: P = S - X - OP
Short Call: P = X - S + OP
Long Put: P = X - S - OP
Short Put: P = S - X + OP
For example, let's say the stock price is $50.00, we bought European call
option with strike $53.00 and paid $2.00 for this option. If option price is
less than $53.00, we will not exercise the option to buy the stock, because
it doesn't make sense to buy security for higher price than it costs on the
market. In this case we lose all initial investment equal to the option price
$2.00. If stock price is more than $53.00, we will exercise the option. For
example if the stock price is $56.00, after exercising the option and
immediately reselling the acquired stock our profit will be:
P = $56.00 - $53.00 - $2.00 = $1.00
if the stock price is $54.00, than the profit is:
P = $54.00 - $53.00 - $2.00 = - $1.00
As we see in latter case we lose money. The reason is that increase of
stock price just by $1.00 above the strike ($53.00) doesn't cover our initial
investment of $2.00, although we still exercise the option to recover at
least $1.00 of initial investment. If the stock price at exercise time is
$55.00 than we exercise the option to cover our initial expenses(equal to
option price):
P = $55.00 - $53.00 - $2.00 = $0.00

This latter case corresponds to option graph intersection point with
horizontal axis on the drawing above.
Distinction between futures and options
34
The option strategies which are applied by me on

live stock market:
1) Date-1/10/2010-Friday
Expiry of contract -28/10/2010-Thursday
Nifty contract
Market outlook- range bound
Strategy- long put butterfly
Buy 1 Oct. 6000 put @ 43.30 = Rs. 2165/Sell 2 Oct.6100 put @71.50 = Rs. 7150/Buy 1 Oct.6200 put @ 117
= Rs.5850/-
Net debit = Rs.865/Risk is limited to Rs 865/Upper breakeven point = 6217

Lower breakeven point=5982.70
THE PAYOFF SCHEDULE

Nifty
Put
2 put
Put
Profit/L
35

SP
5800
5850
5900
5950
6000
6100
6150
6200
6250
6300
6350
6400
Buy
6000
156.7
106.7
56.7
6.7
-43.3
-43.3
-43.3
-43.3
-43.3
-43.3
-43.3
-43.3
Sell
6100
-457
-357
-257
-157
-57
143
143
143
143
143
143
143
Buy
6200
283
233
183
133
83
-17
-67
-117
-117
-117
-117
-117
oss
-17.3
-17.3
-17.3
-17.3
-17.3
82.7
32.7
-17.3
-17.3
-17.3
-17.3
-17.3
THE PAYOFF CHART
Profit/Loss
100
80
60
Profit/Loss
40
20
0
5700 5800 5900 6000 6100 6200 6300 6400 6500
-20
-40
36

2) Date-08/06/2010
Expiry of contract: 24/06/2010-Thursday
Nifty contract
Market outlook: moderately bullish
Strategy: Ratio bull call spread
Current nifty = 4987
Sell 18 lots (s.p 5200) call @33.33/-= Rs. 29970/Buy 5 lots (s.p 5000) call @ 250/-
= Rs. 30000/-
Short Nifty Call 18 Lots (Strike Price 5200) Premium

Received 900@33.30 = 29970
Premiu
Days
Total
Date
m
Profit/Loss
Rs.
Profit/Loss
900
33.3
1080
8-Jun-10
21.3
12
0
10800
9-Jun-10
25
-3.7 -3330
7470
10-Jun1287
10
39.3
-14.3
0
-5400
11-Jun10
35.35
3.95
3555
-1845
14-Jun2637
10
64.65
-29.3
0
-28215
Long Nifty Call 5 Lots (Strike Price 5000) Premium
Paid 250@120 = 30000
Premiu
Days
Total
Date
m
Profit/Loss
Rs.
Profit/Loss
250
120
650
8-Jun-10
94
-26
0
-6500
357
9-Jun-10
108.3
14.3
5
-2925
10-Jun105
10
150.3
42
00
7575
11-Jun167
10
157
6.7
5
9250
14-Jun157
10
220
63
50
25000
37
Net
Profit/Los
s
4300
4545
2175
7405
-3215
Nifty
Close
4987.1
5000.3
5078.6
5119.3
5
5197.7
Profit if
closing today
NIL
75
19650
29837.5
49425
3) Date-08/06/2010
Expiry of contract : 24/06/2010-Thursday
Nifty contract
Market outlook: Range Bound
Strategy: Short Straddle
Current nifty: 4987
Short Nifty call 1 lot (strike price 5000) Premium received 50@ 120= 6000
Short Nifty put 1 lot (strike price 5000) premium received 50@101.80=
5090
Upper BEP =5221
Lower BEP = 4778
Short Nifty Call 1 Lot (Strike Price 5000) Premium
Received 50@120 = 6000
Premiu
Days
Total
Date
m
Profit/Loss
Rs.
Profit/Loss
50
120
130
8-Jun-10
94
26
0
1300
9-Jun-10
108.3
-14.3 -715
585
10-Jun210
10
150.3
-42
0
-1515
11-Jun10
157
-6.7 -335
-1850
14-Jun315
10
220
-63
0
-5000
38
Short Nifty Put 1 Lot (Strike Price 5000) Premium

Received 50@101.80 = 5090
Premiu
Days
Total
Date
m
Profit/Loss
Rs.
Profit/Loss
50
101.8
8-Jun-10
131.9
-30.1 1505
-1505
9-Jun-10
105.1
26.8 1340
-165
10-Jun10
63
42.1 2105
1940
11-Jun697.
10
49.05
13.95
5
2637.5
14-Jun1527
10
18.5
30.55
.5
4165
Net
Profit/Los
s
Breake
ven
5221.8
4778.2
Nifty
Close
Downs
ide
-205
4987.1
208.9
420
5000.3
222.1
425
5078.6
5119.3
5
5197.7
300.4
787.5
-835
341.15
419.5
If today is expiry
Profit
Profit
Net
on SC
on SP
Profit
6000
4445
10445
39
Upsi
de
234.
7
221.
5
143.
2
102.
45
24.1

5985
2070
5090
5090
32.5
-3885
5090
5090
11075
7160
5122.
5
1205
40
Types of traders in derivative market

1. Hedgers:- Hedgers are those who protect themselves from the risk
associated with the price of an asset by using derivatives. A person keeps
a close watch upon the prices discovered in trading and when the
comfortable price is reflected according to his wants, he sells futures
contracts. In this way he gets an assured fixed price of his produce.
In general, hedgers use futures for protection against adverse future price
movements in the underlying cash commodity. Hedgers are often
businesses, or individuals, who at one point or another deal in the
underlying cash commodity.
Take an example: A Hedger pay more to the farmer or dealer of a produce
if its prices go up. For protection against higher prices of the produce, he
hedges the risk exposure by buying enough future contracts of the
produce to cover the amount of produce he expects to buy. Since cash
and futures prices do tend to move in tandem, the futures position will
profit if the price of the produce raise enough to offset cash loss on the
produce.
2. Speculators:
Speculators are somewhat like a middle man. They are never interested in
actual owing the commodity. They will just buy from one end and sell it to
the other in anticipation of future price movements. They actually bet on
the future movement in the price of an asset.
They are the second major group of futures players. These participants
include independent floor traders and investors. They handle trades for
their personal clients or brokerage firms.
Buying a futures contract in anticipation of price increases is known as
going long. Selling a futures contract in anticipation of a price decrease
is known as going short. Speculative participation in futures trading has
increased with the availability of alternative methods of participation.
41

Speculators have certain advantages over other investments they are as
follows:
If the traders judgment is good, he can make more money in the
futures market faster because prices tend, on average, to change
more quickly than real estate or stock prices.
Futures are highly leveraged investments. The trader puts up a

small fraction of the value of the underlying contract as margin, yet
he can ride on the full value of the contract as it moves up and
down. The money he puts up is not a down payment on the
underlying contract, but a performance bond. The actual value of
the contract is only exchanged on those rare occasions when
delivery takes place.
3. Arbitrators:
According to dictionary definition, a person who has been officially chosen
to make a decision between two people or groups who do not agree is
known as Arbitrator. In commodity market Arbitrators are the person who
takes the advantage of a discrepancy between prices in two different
markets. If he finds future prices of a commodity edging out with the cash
price, he will take offsetting positions in both the markets to lock in a
profit. Moreover the commodity future investor is not charged interest on
the difference between margin and the full contract value.
42
Types of Futures and Options Margins

Margins on Futures and Options segment comprise of the following:
1) Initial Margin
2) Exposure margin
In addition to these margins, in respect of options contracts the following

additional margins are collected;
1) Premium Margin
2) Assignment Margin
How is Initial Margin Computed?
Initial margin for F&O segment is calculated on the basis of a portfolio (a

collection of futures and option positions) based approach. The margin
calculation is carried out using software called -SPAN (Standard Portfolio
Analysis of Risk). It is a product developed by Chicago Mercantile
Exchange (CME) and is extensively used by leading stock exchanges of
the world.
SPAN uses scenario based approach to arrive at margins. It generates a
range of scenarios and highest loss scenario is used to calculate the initial
margin. The margin is monitored and collected at the time of placing the
buy / sell order.
The SPAN margins are revised 6 times in a day -once at the beginning of
the day, 4 times during market hours and finally at the end of the day.
Obviously, higher the volatility, higher the margins.
How is exposure margin computed?

In addition to initial / SPAN margin, exposure margin is also collected.
43

Exposure margins in respect of index futures and index option sell
positions have been currently specified as 3% of the notional value.
For futures on individual securities and sell positions in options on
individual securities, the exposure margin is higher of 5% or 1.5 standard
deviation of the LN returns of the security (in the underlying cash market)
over the last 6 months period and is applied on the notional value of
position.
How is Premium and Assignment margins computed?

In addition to Initial Margin, a Premium Margin is charged to trading
members trading in Option contracts.
The premium margin is paid by the buyers of the Options contracts and is
equal to the value of the options premium multiplied by the quantity of
Options purchased.
For example, if 1000 call options on ABC Ltd are purchased at Rs. 20/-,
and the investor has no other positions, then the premium margin is Rs.
20,000.
The margin is to be paid at the time trade.
Assignment Margin is collected on assignment from the sellers of the
contracts.
How Marked to Market Margins are computed?

1. Future contracts:-The open positions (gross against clients and net of
proprietary/ self trading) in the futures contracts for each member are
marked to market to the daily settlement price at the end of each day is
the weighted average price of the last half an hour of the futures contract.
The profits/losses arising from the different between the trading price and
the settlement price are collected/ given to all clearing members.
2. Option contracts:-the marked o market for option contracts is computed
and collected as part of the Initial Margin in the form of Net Option Values.
The Initial Margin is collected on an online real time basis based on the
data feeds given to the system at discrete time intervals.
44
How Client Margins are computed?

Client Members and Trading Member are required to collect initial margins
from all their clients. The collection of margins at client level in the
derivatives markets is essential as derivatives are leveraged products and
non-collection of margins at the client level would provide zero cost
leverage. In the derivative markets all money paid by the client towards
margins is kept in trust with the Clearing House/ Clearing Corporation and
in the event of default of the Trading or Clearing Member the amounts
paid by the client towards margins are segregated and not utilized
towards the dues of the defaulting member.
Therefore, Clearing members are required to report on a daily basis details
in respect of such margin amounts due and collected from their Trading
members/ clients clearing and settling through them. Trading members
are also required to report on a daily basis details of the amount due and
collected from their clients. The reporting of the collection of the margins
by the clients is done electronically through the system at the end of each
trading day. The reporting of collection of client level margins plays a
crucial role not only in ensuring that members collect margin from clients
but it also provides the clearing corporation with a record of the quantum
of funds it has to keep in trust for the clients.
45
Comparative Analysis
Comparative analysis is easy to understand when we are analysis with the

example of the real market situation.
Now I would like to quote a real life example during my internship where I
understood the actual comparison of equity and derivative market.
Example:
There was an investor Mr. Jaichand. He has Rs. 1, 00,000/-and he wants to
invest it in share market. Now he has two options either to invest in equity
cash market or equity derivative market (F&O).
Now suppose if he invest in equity cash market and buy shares of Rs. 1,
00, 000/- and diversified risk so he buys different scrips. So he purchases
10 RIL shares of Rs. 2350/-each. 10 L&T shares of Rs 800/-each, 15
46

Religare Enterprises Shares of Rs. 370/-each, 20 ICICI bank shares of Rs.
800/-each, 10 Tata power shares of Rs. 1250 each and 10 BHEL shares of
Rs. 1595/each.
So for investing Rs. 1, 00,000/-in equity cash market he has to pay Rs.
1,00,000/-and gets the delivery of the shares.
Now suppose if he invest in equity derivative market then he will able to
purchase the shares worth Rs. 5,00,000/-though he has capital of Rs.
1,00,00/-only, because of the margin payment.
But he has to purchase the share in a lot size. So he is able to purchase
the 1 lot (100 shares) of RIL at Rs. 2350/-, 1 lot (50 shares) of L&T at
2650/-, 2 lots (100 shares each) of Religare Enterprises at Rs. 370/-and 1
lot (70 shares) of ICICI bank at Rs. 800/-. Here Mr. Jaichand has to pay Rs.
1,00,000/-as a margin money and he is able to purchase a shares worth
Rs. 5,00,000/But he has to pay the full amount of money at T+3 basis. So
he has to pay the remaining amount on the 3rd day of the trading if he
wants the delivery.
I. Returns
Mr. Jaichand gets return on equity by two ways. One is when the share
price of the holding shares will increases in futures, called as capital
appreciation. Second is by getting a dividend income from the holding
shares.
Mr. Jaichand gets return on equity derivative when the future prices of the
shares are increase in short term called as capital gain through price
fluctuation or through options premium.
II. Risk:
There are four types of risk involved in equity cash market.
1. Company Specified risk:-If company is not performing well than
process of the shares will declining and vice versa.
2. Sector specified risks:-If the sector is not performing well i.e. power
sector, metal sector, oil & gas sector, banking sector then prices of the
shares will go down and vice versa.
47

3. Global risk:-If global cues are positive then prices will increases but if
global cues are not good than prices of shares will go down.
4. General market risk:-General market risk is also affect the equity
cash market like inflation, banks interest rates etc.
So Mr. Jaichand has to consider all these risk factors while dealing in the
equity
cash market.
There are four types of risk involved in equity derivative market.

1. Market risk:-In derivative market we have to calculate the market risk
or mark to market risk involved in the stocks or securities, that is the
exposure to potential loss from fluctuations in market prices (as opposed
to changes in credit status). It is calculated on the tradable assets i.e.,
stocks, currencies etc.
2. Credit risk: It may possible in derivative contract that the
counterparty may be fail to perform the contract or say defaulted then it
is a risk for us. It is calculated on non-tradable assets i.e., loans. So
generally it is for long term purpose.
3. Liquidity Risk:-If Mr. Jaichand will not able to find a price( or a price
within a reasonable tolerance in terms of the deviation from prevailing or
expected prices) for one or more of its financial contracts in the secondary
market. Consider the case of a counterparty who buys a complex option
on European interest rates. He is exposed to liquidity risk because of the
possibility that he cannot find anyone to make him a price in the
secondary market and because of the possibility that the price he obtains
is very much against him and the theoretical price for the product.
4. Settlement Risk:-The risk of non-payment of an obligation by a
counterparty to a transaction, exacerbated by mismatches in payment
timings.
So, Mr. Jaichand has to consider all these factors while dealing in the
equity derivative market.
I. Margins:
Now Mr. Jaichand has also seen the margin paid in the equity cash
segment.
48

1. Var Margin: -Now Mr. jaichand bought shares of a company. Its market
value today is Rs. 1, 00,000/-Obviously, we do not know what would be
the market value of these shares next day. Now Mr. Jaichand holding these
shares may, based on VaR methodology, say that 1-day Var is Rs. 1,
00,000/-at the 99% confidence level. This implies that under normal
trading conditions the investors can with 99% confidence, say that the
value of shares would not go down by more than Rs. 1,00,000/- within
next 1-day.
2. Extreme loss margin: -In the above situation, the VaR margin rate for
shares of RIL was 13%. Suppose that SD would be 1.5 x 3.1= 4.65. Then
5% (which is higher than 4.65%) will be taken as the Extreme Loss margin
rate.
Therefore, the total margin on the security would be 18% (13% VaR
Margin + 5% Extreme Loss margin). As such, total margin payable( VaR
margin + extreme loss margin) on a trade of Rs. 23, 500/- woud be 4,
230/3.
3.Mark to Market Margin:-Now Mr. Jaichand purchased 10 shares of RIL

@ Rs. 2350/-, at 11 am on May 12, 2009. If close price of the shares on
that happened to be Rs. 2350, then the buyer faces a notional loss of Rs.
500/-on his buy position. In technical term this loss is called as MTM loss
and is payable by May 13, 2009 (that is next day of the trade) before the
trading begins.
In case, price of the shares falls further by the end of May 13 2009 to Rs.
2200/-, then buy postion would show a further loss of Rs. 1, 000/-. This
MTM loss is payable by next day.
Now we will consider the margin payable under the equity derivatives
segment.
i) Initial Margin: The initial margin required to be paid by the investor
would be equal to the highest loss the portfolio would suffer in any of the
scenarios considered. The margin is monitored and collected at the time
of placing the buy/ sell order. As higher the volatility, higher the initial
margin.
ii) Exposure Margin: Exposure margins in respect of index futures and
index option sell position are 3% of the notional value.
49

iii) Premium margin:-If 1000 call option on RIL are purchased at Rs.
20/and Mr. Jaichand has no other positions, then the premium margin Rs.
20,000.
iv) Assignment Margin: Assignment Margin is collected on assignment
from the sellers of the contract.
I. Duration:
Generally equity market is a long term market and people invested in it
for more than one year and then only they get good return on equity.
Generally any safe investors can invest in it because here risk is
comparatively low then derivative market.
While in derivative market investors are investing for less than one yea,
generally for 2 months or 3 months. Here they get high returns on it
because they are bringing high risk.
II. Participants:
Generally any long term investors can invest in equity or hedgers are
investing in the equity, who wants to reduce their risk. Any person who
wants to be safe investors and wanted to earn a good amount of returns
after a period of more than one year is also invested in equity.
In derivative market mostly speculators and arbitragers are invested
because they wanted quick money in short time period and hedgers are
also invested in derivative market to reduce their risk.
III. Expiry date:

Its a last Thursday of any month in case of a derivative market but no
such things in case of an equity market.
50
Conclusion
This project has covered several areas. Its main conclusions are:
Derivatives market growth continues almost irrespective of equity
cash market turnover growth. Since 2000 Cash equity turnover has
fallen in the developed markets, but derivatives turnover continued
to rise steeply and steadily.
Equity market volume and derivative market notional value are
strongly correlated- with a ratio significant differences between
individual markets.
A number of cash equity markets- particularly in developing Asia- do
not have equity derivatives markets. Comparison of their cash
market volumes with those that do have derivative exchanges
shows that the markets without derivatives are of similar size. I am
not convinced that market or infrastructure differences explain this,
but suspects that regularity barriers have effectively prevented the
development, markets in several developing Asian countries.
51
References
Securities Laws and Regulations of Financial Markets
National Securities Depository Limited
Fundamentals of Futures & Options Markets- John C. Hull
Financial Derivatives- S. L. Gupta
Websites:www.world-exchange.org
www.nseindia.com
www.bseindia.com
www.religaresecurities.com
www.moneycontrol.com
www.indiamart.com
www.finpipe.com
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Empirical Analysis of Equity Derivative

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Empirical analysis of equity & derivatives