Project Name- Future of Derivatives in India

Name- Pratyush Kesarwani

Student number- 77122600943

DECLARATION I hereby declare that this project titled “A STUDY ON

FINANCIAL DERIVATIVES (FUTURES & OPTIONS)” submitted by me to the
department of Business Management, is a bonafide work undertaken by me and it
is not submitted to any other university or institution for the award of any degree
/certificate or published any time before.

ABSTRACT
The emergence of the market for derivatives products, most notably forwards,
futures and options, can be tracked back to the willingness of riskaverse economic
agents to guard themselves against uncertainties arising out of fluctuations in asset
prices. Derivatives are risk management instruments, which derive their value from
an underlying asset. The following are three broad categories of participants in the
derivatives market Hedgers, Speculators and Arbitragers. Prices in an organized
derivatives market reflect the perception of market participants about the future
and lead the price of underlying to the perceived future level. In recent times the
Derivative markets have gained importance in terms of their vital role in the
economy. The increasing investments in stocks (domestic as well as overseas) have
attracted my interest in this area. Numerous studies on the effects of futures and
options listing on the underlying cash market volatility have been done in the
developed markets. 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 cash market the profit/loss of the investor depends on the market price of
the underlying asset. The investor may incur huge profit or he may incur
huge loss. But in derivatives segment the investor enjoys huge profits with
limited downside. Derivatives are mostly used for hedging purpose. 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.
In a nutshell the study throws a light on the derivatives market.

ACKNOWLEDGEMENT
With the deep sense of gratitude, I wish to acknowledge the support and help
extended by all the people, in successful completion of this project work.
I express my gratitude to our Principal XXX for his consistent support, Head
of the Department XXX for his encouragement. I would like to thank all
the faculty members who have been a strong source of inspiration through
out the project directly or indirectly.

INTRODUCTION:-
The emergence of the market for derivatives products, most notably
forwards, futures and options, can be tracked back to the willingness of risk-averse
economic agents to guard themselves against uncertainties arising out of
fluctuations in asset prices. By their very nature, the financial markets are marked
by a very high degree of volatility. Through the use of derivative products, it is
possible to partially or fully transfer price risks by locking-in asset prices. As
instruments of risk management, these generally do not influence the fluctuations
in the underlying asset prices. However, by locking-in asset prices, derivative
product minimizes the impact of fluctuations in asset prices on the profitability and
cash flow situation of risk-averse investors.
Derivatives are risk management instruments, which derive their value
from an underlying asset. The underlying asset can be bullion, index, share, bonds,
currency, interest, etc.. Banks, Securities firms, companies and investors to hedge
risks, to gain access to cheaper money and to make profit, use derivatives.
Derivatives are likely to grow even at a faster rate in future.

NEED FOR STUDY :

In recent times the Derivative markets have gained importance in terms of
their vital role in the economy. The increasing investments in derivatives
(domestic as well as overseas) have attracted my interest in this area.
Through the use of derivative products, it is possible to partially or fully
transfer price risks by locking-in asset prices. As the volume of trading is
tremendously increasing in derivatives market, this analysis will be of
immense help to the investors.

OBJECTIVES OF THE STUDY:

1) To analyze the operations of futures and options.
2) To find the profit/loss position of futures buyer and seller and also the
option writer and option holder.
3) To study about risk management with the help of derivatives.

SCOPE OF THE STUDY:

The study is limited to “Derivatives” with special reference to futures and
option in the Indian context and the Inter-Connected Stock Exchange has been
taken as a representative sample for the study. The study can’t be said as totally
perfect. Any alteration may come. The study has only made a humble attempt at
evaluation derivatives market only in India context. The study is not based on
the international perspective of derivatives markets, which exists in NASDAQ,
CBOT etc.

LIMITATIONS OF THE STUDY: The following are the limitation of this

study
1) The scrip chosen for analysis is ICICI BANK, SBI & YES BANK
and the contract taken is January 2008 ending one –month contract.
2) The data collected is completely restricted to ICICI BANK, SBI &
YES BANK of January 2008; hence this analysis cannot be taken universal.

RESEARCH METHODOLOGY:
Data has been collected in two ways. These are:
Secondary Method:
Various portals, www.nseindia.com
Financial news papers, Economics times.
Books- Derivatives Dealers Module Work Book - NCFM
(October 2005)
Gordon and Natarajan, (2006) ‘Financial Markets and
Services’ (third edition) Himalaya publishers

LITERATURE REVIEW: Behaviour of Stock Market Volatility after

Derivatives
Golaka C Nath , Research Paper (NSE) Financial market liberalization since
early 1990s has brought about major changes in the financial markets in India.
The creation and empowerment of Securities and Exchange Board of India
(SEBI) has helped in providing higher level accountability in the market. New
institutions like National Stock Exchange of India (NSEIL), National Securities
Clearing Corporation (NSCCL), National Securities Depository (NSDL) have
been the change agents and helped cleaning the system and provided safety to
investing public at large. With modern technology in hand, these institutions did
set benchmarks and standards for others to follow. Microstructure changes
brought about reduction in transaction cost that helped investors to lock in a
deal faster and cheaper.
One decade of reforms saw implementation of policies that have improved
transparency in the system, provided for cheaper mode of information
dissemination without much time delay, better corporate governance, etc.
The capital market witnessed a major transformation and structural change
during the period. The reforms process have helped to improve efficiency in
information dissemination, enhancing transparency, prohibiting unfair trade
practices like insider trading and price rigging. Introduction of derivatives in
Indian capital market was initiated by the Government through L C Gupta
Committee report. The L.C. Gupta Committee on Derivatives had
recommended in December 1997 the introduction of stock index futures in
the first place to be followed by other products once the market matures. The
preparation of regulatory framework for the operations of the index futures
contracts took some more time and finally futures on benchmark indices
were introduced in June 2000 followed by options on indices in June 2001
followed by options on individual stocks in July 2001 and finally followed
by futures on individual stocks in November 2001.

Do Futures and Options trading increase stock market volatility?

Dr. Premalata Shenbagaraman, Research Paper (NSE)
Numerous studies on the effects of futures and options listing on the underlying
cash market volatility have been done in the developed markets. The empirical
evidence is mixed and most suggest that the introduction of derivatives do not
destabilize the underlying market. The studies also show that the introduction of
derivative contracts improves liquidity and reduces informational asymmetries
in
the market. In the late nineties, many emerging and transition economies have
introduced derivative contracts, raising interesting issues unique to these
markets.
Emerging stock markets operate in very different economic, political,
technological andsocial environments than markets in developed countries like
the USA or the UK. This paper explores the impact of the introduction of
derivative trading on cash market volatility using data on stock index futures
and
options contracts traded on the S & P CNX Nifty (India). The results suggest
that
futures and options trading have not led to a change in the volatility of the
underlying stock index, but the nature of volatility seems to have changed
postfutures. We also examine whether greater futures trading activity (volume
and
open interest) is associated with greater spot market volatility. We find no
evidence of any link between trading activity variables in the futures market
and spot market volatility. The results of this study are especially important to
stock exchange officials and regulators in designing trading mechanisms and
contract specifications for derivative contracts, thereby enhancing their value as
risk management tools.
 DERIVATIVES

The emergence of the market for derivatives products, most notably forwards,
futures and options, can be tracked back to the willingness of risk-averse
economic
agents to guard themselves against uncertainties arising out of fluctuations in
asset
prices. By their very nature, the financial markets are marked by a very high
degree of volatility. Through the use of derivative products, it is possible to
partially or fully transfer price risks by locking-in asset prices. As instruments
of
risk management, these generally do not influence the fluctuations in the
underlying asset prices. However, by locking-in asset prices, derivative product
minimizes the impact of fluctuations in asset prices on the profitability and cash
flow situation of risk-averse investors.
Derivatives are risk management instruments, which derive their value
from an underlying asset. The underlying asset can be bullion, index, share,
bonds,
 currency, interest, etc.. Banks, Securities firms, companies and investors to
hedge risks, to gain access to cheaper money and to make profit, use
derivatives.
Derivatives are likely to grow even at a faster rate in future.
DEFINITION: Derivative is a product whose value is derived from the value
of an underlying
asset in a contractual manner. The underlying asset can be equity, forex,
commodity or any other asset.
1) Securities Contracts (Regulation)Act, 1956 (SCR Act) defines “derivative”
to 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 ofprices, of
underlying securities.

Derivative products initially emerged as hedging devices against fluctuations in

commodity prices, and commodity-linked derivatives remained the sole form of
such products for almost three hundred years. Financial derivatives came into
spotlight in the post-1970 period due to growing instability in the financial
markets. However, since their emergence, these products have become very
popular and by 1990s, they accounted for about two-thirds of total transactions in
derivative products. In recent years, the market for financial derivatives has grown
tremendously in terms of variety of instruments available, their complexity and
also turnover. In the class of equity derivatives the world over, futures and options
on stock indices have gained more popularity than on individual stocks, especially
among institutional investors, who are major users of index-linked derivatives.
Even small investors find these useful due to high correlation of the popular
indexes with various portfolios and ease of use. The lower costs associated with
index derivatives vis–a–vis derivative products based on individual securities is
another reason for their growing use.

CONCLUSION:
There is an increasing sense that financial derivative market has a vital role in risk
management and economic growth .Financial derivatives have
earned a significant place in all the financial instruments (products), due to
innovation and revolutionized the landscape. The Indian derivative
market has achieved tremendous growth over the years, and also has a long history
of trading in various derivatives products. The derivatives
market has seen ups and downs. The new and innovative derivative products have
emerged over the time to meet the various needs of the different
types of investors. Financial derivatives have earned a well deserved extremely
significant place among all the financial instruments (products),
due to innovation and revolutionized the landscape. The growth of derivatives in
the recent years has surpassed the growth of its counterpart
globally. Finally we can say there is big significance and contribution of
derivatives to Indian market and good importance in future prospects .