ONLINE TRADING DERIVATIVES

University Of Mumbai

“A Study on Online Trading

Derivatives”
Bachelor of Management
Studies
Semester VI
Submitted
In Partial Fulfillment of the requirements
For the Award of Degree of
Bachelor of Management Studies
By
(Kishori Dilip Keluskar)
(Roll No. 317027)
WESTERN COLLEGE OF COMMERCE
AND BUSINESS MANAGEMENT
Plot No. 2, Sector 9, Sanpada,
Navi Mumbai – 400705
2019-2020
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Declaration by learner

I the undersigned Miss. Kishori Dilip Kelskuar here by, declare that the work embodied in
this project work titled “Online Trading Derivatives”, forms my own contribution to the
research work carried out under the guidance of Prof. Durga Sharma is a result on own
research work and has not been previously submitted to any other University for any other
Degree/ Diploma to this or any other University.
Wherever reference has been made to previous works of others, it has been clearly indicated
as such and included in the bibliography.
I, here by further declare that all information of this document has been obtained and
presented in accordance with academic rules and ethical conduct.

Name and Signature of the learner

Certified by
Name and Signature of the Guiding Teacher
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Certificate

This is to certify that Ms. Kishori Dilip Keluskar, Roll No: 317027 of Third Year
ONLINE TRADING DERIVATIVES

INDEX
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1.1 INTRODUCTION:
In our present day economy, finance is defined as the provision of money at the time
when it is required. Every enterprise, whether big, medium or small, needs finance to carry
on its operations and to achieve its targets in fact; finance is so indispensable today that it
is rightly said that it is the lifeblood of an enterprise.

The term ‘ownership securities’ also known as ‘capital stock ‘represents shares. Shares
are the most universal forms of raising long-term funds from the market. Every company,
except a company limited by guarantee, has a statutory right to issued shares.

The capital of a company is divided into a number of equal parts known as shares.
According to Farewell .j, a share is, “the interest of a shareholder in the company,
measured by a sum of money, for the purpose of liability in the first place, and if
interest in the second, but also consisting a series of mutual covenants entered into by
all the shareholders interest’. Section 2(46) of the companies act, 1956 defines it as “a
share in the share capital of a company, and includes stock except where a distinction
between stock and shares expressed or implied.

Share market is of two types. They are cash market and derivative market.

Cash markets are the secondary markets where trading in existing securities is
done. Listing of new issues for investment and disinvestments by savers/investors takes
place. It imparts liquidity or in-cash ability to stocks and shares. Stock exchange is a
market in which securities are bought and sold and it is an essential component of a
developed capital markets.
The securities contracts (Regulation) Act, 1956, defines Stock Exchange as
follows: “It is an association, organization or body of individuals, whether incorporated or
not, established for the purpose of assisting, regulating and controlling of business in
buying, selling and dealing in securities”
A stock exchange, thus imparts marketability and liquidity to securities,
encourage investments in securities and assists corporate growth. Stock exchanges are
organized and regulated markets for various securities issued by corporate sector and
other institutions.
Derivatives are 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, fore ex. 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.

In the last 20 years derivatives have become notably important in the world of
finance. Futures and options are now globally traded on many exchanges. Forward
contracts, Swaps and many different types of options are regularly conducted by outside
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exchanges by financial institutions, fund managers and corporate treasurers in what is

termed the over the counter market. Derivatives are also sometimes added to a bond or
stock issue. Further, the very nature of volatility in the financial markets, the use of
derivative products, it is possible to partially or fully transfer price risks by locking in asset
prices. But these instruments of risk management are generally do not influence the
fluctuations in the underlying asset prices. However, by locking asset prices, the derivative
products minimize the fluctuations in the asset prices on the profitability and cash flow
situations on risk to the investor.

The derivatives are becoming increasingly important in world of markets as a tool

for risk management. Derivative instruments can be used to minimize risk. Derivatives
are used to separate the risks and transfer them to parties willing to bear these risks. The
kind of hedging that can be obtained by using derivatives is cheaper and more convenient
than what could be obtained by using cash instruments. It is so because, when we use
derivatives for hedging, actual delivery of the underlying asset is not at all essential for
settlement purposes. The profit or loss on derivative deal alone is adjusted in the
derivative market.

Derivatives contract have several variants. The most common variants are forwards,
futures, options and swaps. The following three broad categories of participants - hedgers,
speculators, and arbitrageurs trade in derivatives market. Hedgers face risk associated with
the price of an asset. They use futures or options markets to reduce or eliminate this risk.
Speculators wish to bet on future movements in the price of an asset. Futures and options
contract can give them an extra leverage; that is, they can increase advantage of a
discrepancy between prices in two different markets. If, for example, they see the futures
price of an asset getting out of line with cash price, they will take offsetting positions in the
two markets to lock in a profit.

Derivative products initially a merged as hedging devices against fluctuations is

commodity prices, and commodity-linked derivatives remained the sole from for the 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 as grown tremendously in terms of variety
of instruments available, their complexity and also turnover.
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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 various portfolios and ease of use. The lower costs
associated with index derivatives vis-à-vis derivative products based on individual securities
is another reason for their growing use.

The first step towards introduction of derivatives trading in India was the promulgation of the
Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on option in
securities.

The committee submitted its report on March 17, 1998 prescribing necessary pre-
conditions for introduction of derivatives trading in India. The committee recommended that
derivatives should be declared as ‘securities’ so that regulatory framework applicable to
trading of ‘securities’ could also govern trading of securities. SEBI also set up a group in
June 1998 under the Chairmanship of Prof. J. R. Varna to recommend measures for risk
containment in derivatives market in India. These instruments can be used to speculate or to
manage risk in the equity markets.

Derivatives are products whose values are derived from one of more basic variables
called bases. These bases can be underlying assets such as foreign currency, stock or
commodity, bases or reference rates such as LIBOR or US Treasury Rate etc. For example,
an Indian exporter in anticipation of the receipt of dollar-denominated export proceeds may
wish to sell dollars at a future date to eliminate the risk of exchange rate volatility by the
date. Such transactions are called derivatives, with the spot price of dollar being the
underlying asset.

Derivatives thus have no value of their own but derive it from the asset that is being
dealt with under the derivative contract. For instance, look at an ashtray. It has no value of
its own but gains its importance only when one smokes and gain if one wants to collect that
ash at one place instead of dirtying the whole room with cigarette ash and its stubs. A smoker
can hedge against the risk of stewing the cigarette stubs and ash all around the room.

Similarly a financial manager can hedge himself from the risk of a loss in the price
of a commodity or stock by buying a derivative contract. Thus derivative contracts acquire
their value from the spot prices of the assets that are concerned by the contract.
The primary purpose of a derivative contract is to transfer “risk” from one party to
another i.e. risk in a financial sense in transferred from a party that wants to get rid of it to
another party that is willing to take it on. Here, the risk that is being dealt with is that of
price risk. The transfer of such a risk can therefore be speculative in nature or act as a hedge
against price movement in a current or anticipate physical position.
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A derivative is an instrument whose value is derived from the value of one or more
underlying which can either in the form of commodities, precious meat, currencies, bonds,
stock and stock indices”. As the price of the wheat derivatives would be determined or based
on the prices of wheat itself.

Given the fast change and growth in the scenario of the economic and financial
sector have brought a much broader impact on derivatives instrument. As the name signifies,
the value of this product is derived of based on the prices of currencies, interest rate (i.e.
bonds), share and share indices, commodities, etc. Not going into very back, financial
derivatives just came into existence in the early 1980’s. Here the principal instruments,
clubbed under the general term derivatives, include

1. Futures & Forwards

2. Options
3. Swaps
4. Warrants
5. Exotic and are the modern tools of financial risk management.

All pricing of derivatives is done by arbitrage, and by arbitrage alone. Here, there is a
relationship between the price of the spot and the price in the futures. If this relationship is
violate, then an arbitrage opportunity is available, and we people exploit this opportunity,
the price reverts back to its economic value. Therefore, arbitrage is the basic requirement for
pricing. The role of liquidity i.e. the low transaction costs is in making arbitrage checkup
and convenient. Derivative markets in Brazil are some of the largest markets in the world
even first derivative dealing were started in USA. We can even know that as the prices of
the forward contacts are based on future therefore it can even be termed as derivative
instrument.
Derivative contracts have several variants. The most common variants are forward,
futures, options and swaps. A brief note on the various derivative that are used are as
follows:

Forwards. A forward contract is a customized contract between two entities,

where settlement takes place on a specific date in future at today pre agreed price.

FUTURES. A future contract is an agreement between two parties to buy or sale

an asset at a certain time in the future at a certain price. Future contracts are special types of
forward contracts means that the former are standardized exchange traded contracts.
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OPTIONS. Options are of two types

1) Call Option - Calls give the buyer the right but not the obligation the buy a
given quantity of the underlying asset, at a given price on or before a given future date.
2) Put Option- Puts option given the buyer the right but not obligation to sell
a given quantity of the underlying asset, at a given price on or before a given date.

WARRANTS. Longer dated options are called warrants and are generally traded
over-the-counter. (OTC Market)

SWAPS. Swaps are private agreements between two parties to exchange cash
flows
1) Interest rate swaps: interest related cash flows

2) Currency swaps: swapping both principal and interest between the parties.

LEAPS. LEAPS means Long-Term Equity Anticipation Securities, Maturity of

up to three years.

BASKETS. Basket options are options on portfolios of underlying assets.

1.2 Need for Study:

Although financial derivatives have existed for a considerable period of time they
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have become major forces in financial market only since the early 1970s. The 1970s constituted a
watershed in financial history, partly because the fixed exchange rate regime (the Bretton Woods
Systems) that had operated since the 1940s, broke down.

These developments established the context in which financial derivatives could develop,
flourish and became a major force in world financial markets. When the Breton Wood
Systems collapsed in the early 1970s, a regime of fixed exchange rates gave way to financial
environment in which exchange rates were constantly changing in response to pressure of
demand and supply. The fact that currency prices move constantly and often substantially, in
the new situation meant that businesses face new risks.

Currency derivatives developed in response to the need to manage these risks. In other words
the new system of variable exchange rates generated a need to find techniques to reduce the
risks arising and simultaneously created opportunities for speculations. Thus financial
derivatives develop as a vehicle for these two forms of economic activities. When an investor
feels the market will fall, he can hedge this position by selling. Say, Nifty futures against his
portfolio.

Trading in derivatives in India was introduced in June 2000 on NSE market. The SEBI
governs this market by providing the necessary rules and regulations. Derivatives allow us to
manage risks more efficiently by unbundling the risks and allow either hedging or taking
only (or more if desired) risk at a time.

During the present period, banks have increased their exposure to OTC derivative
instruments at such a faster rate that supervisory authorities the world over are getting
worried about the risks such exposures involve for the banks. The explosive growth in
derivatives has been the result both of intense competition amongst major international
banks (as the role have been changed to profitability) and the need of the corporate world,
indeed the whole “real” economy, to hedge exposures in volatile markets. As the increase of
players entering market which decrease the margins. Derivatives provide their important
economic functions:
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(1) Risk management

(2) Price discovery; and
(3) Transactional efficiency

The risk which are generally seen in derivatives are generally of four types:

 Credit risk To study the process of derivative market

(1) To make a comparative study with cash market

(2) Market risk
(3) Legal risk
(4) Operations risk

This should be the following measure to reduce disasters with derivatives: -

 At the level of exchanges, position limits and surveillance procedures should be sound.
 At the level of clearing houses, margin requirements should be stringently enforced,
even when dealing is with large institutions.

 At the level of individual companies with positions in the market, modern risk
measurement systems should be established alongside the creation of capabilities in
trading in derivatives. The basic idea, which should be steadfastly used when thinking
about returns, is that risk also merits measurement.

But why are derivatives such a big hit in Indian market?

 The derivatives products – index futures, index options, stock futures and stock options
provide a carry forward facility for investors to take a position (bullish or bearish) on
an index or a particular stock for a period ranging from one to three months.

 The current daily settlement in the cash market has left no room for speculation. The
cash market has turned into a day market, leading to increasing attention to derivatives.

 Unlike the cash market of full payment or delivery, you don’t need many funds to buy
derivatives products. By paying a small margin, one can take a position in stocks or
market index.
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 They provide a substitute for the infamous BADLA system.

The derivatives volume is also picking up in anticipation of reduction of contract size from
the current Rs.200, 000 to Rs.100, 000.

 Everything works in a rising market. Unquestionably, there is also a lot of trading

interest in the derivatives market.

1.3 Objectives of the study:

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 To study the process of derivative market.

 To make a comparative study with cash market.

 To analyze risks and benefits of derivative market.

 To analyze through questionnaire how investors are benefited in Derivative market.

1.4 Methodology:

Facts expressed in quantity form can be termed as “data”. Data maybe classified either as:

i. Primary data
ii. Secondary data

i) Primary Data:

Primary data is the first hand information that a research gets from various sources
like respondents, analogous case situations and examination. Primary data is the data that is
generated by the research for the specific purpose of research situation at hand.

ii.) Secondary Data:

Secondary data is already published data collected for some purpose other than the
one confronting the research at a given point of time. The secondary data can be gathered
from various sources like statistics, libraries, research agencies etc. In this case the secondary
information is to be collected from newspapers like “Business line” and business magazines
like “Business Today” and Internet.

1.5 Advantages of Online Trading Derivatives:

Management of risk

Efficiency in trading
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Speculation

Price discovery

Price stabilization

Liquidity

Leverage

Encourage competition