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A Project Report On:

Hedging Using Options Strategies

(With special reference to KARVY)


Roll no. - 8167



serial no Topic Page no.

1 Certificate by organization 4
2 Acknowledgement 5
3 Executive summary 6
4 Company overview 7-18
5 Introduction 19
6 Research Methodology 20-22
7 Derivatives 23-26
8 Derivative – Forward 27
9 Derivative – Futures 28-30
10 Derivative – Options 31-33
11 Option Strategies 34-35
12 Hedging 36-38
13 Analysis & Interpretation 39-54
14 Findings on Cases 55-57
15 Suggestions 58-60
16 Conclusion 61
17 Bibliography 62


I, Mr Rushab Mehta do hereby declare that the project report titled

“Hedging Using Options Strategies” is a genuine research work
undertaken by me and it has not been published anywhere earlier.



Rushab Mehta

ISB&M, Pune

Mr. Ravi Gaekwade
Head ,
Pune Region, KARVY

Certificate by the organization:

This is to certify that Mr Rushab Mehta, pursuing PGDBM at

International School of Business Media, Pune has worked under
my supervision and guidance on his Summer Project entitled
“Hedging Using Options Strategies” at Karvy Stock Broking
Limited, Pune from April 14th 2008 to June 14th 2008. ” To the
best of my knowledge this is an original piece of work.


Sometimes words fall short to show gratitude, the same happened with me during this
project. The immense help and support received from Karvy stock broking limited
overwhelmed me during the project.

My sincere gratitude to Mr.Ravi Gaekwade (Head, Pune region, Karvy) for providing
me with an opportunity to work with Karvy stock broking limited.

I am highly indebted to Mr. Makrand., product head, Karvy Wanowarie Branch, and
company project guide, who has provided me with the necessary information and his
valuable suggestion and comments on bringing out this report in the best possible way.

I am grateful to all of the members of Wanowarie branch, who have helped me in the
successful completion of this project.

Last but not the least, my heartfelt love for my parents, whose constant support and
blessings helped me throughout this project.

Executive summary:

This project has been a great learning experience for me; at the same time it gave me
enough scope to implement my analytical ability. This project as a whole can be divided
into two parts:

 The first part gives an insight about Derivatives and its various aspects. It is
purely based on whatever I learned at Karvy. One can have a brief knowledge
about derivatives and all its basics through the project. Other than that the real
servings come when one moves ahead. Some of the most interesting questions
regarding derivatives have been covered.

All the topics have been covered in a very systematic way. The language has
been kept simple so that even a layman could understand. All the data have been
well analyzed with the help of charts and graphs.

 The second part consists of data and their analysis, collected through a survey
done on people. The data collected has been well organized and presented. Hope
the research findings and conclusions will be of use.

Organization overview


“Success is a journey, not a destination.” If we look for examples to prove this

quote then we can find many but there is none like that of Karvy. Back in the year 1981, five
people created history by establishing Karvy and company which is today known as Karvy, the
largest financial service provider of India.

Success sutras of Karvy:

The success story of Karvy is driven by 8 success sutras adopted by it namely trust,

integrity, dedication, commitment, enterprise, hard work and team

play, learning and innovation, empathy and humility. These are the values
that bind success with Karvy.

Vision of Karvy:

To achieve & sustain market leadership, Karvy shall aim for complete customer satisfaction, by
combining its human and technological resources, to provide world class quality services. In the
process Karvy shall strive to meet and exceed customer's satisfaction and set industry standards.

Mission statement:
“Our mission is to be a leading and preferred service provider to our
customers, and we aim to achieve this leadership position by building
an innovative, enterprising , and technology driven organization which
will set the highest standards of service and business ethics.”

The success ladder:

Company overview:

Karvy was established as Karvy and company by five chartered accountants during the
year 1979-80, and then its work was confined to audit and taxation only. Later on it
diversified into financial and accounting services during the year 1981-82 with a capital
of rs.150000. it achieved its first milestone after its first investment in technology. Karvy
became a known name during the year 1985-86 when it forayed into capital market as

Evolution of KARVY:

It is well said that success is a journey not a destination and we can see it being proved
by Karvy. Under this section we will see that how this “Karvy and company” of 1980
became “Karvy” of 2008. Karvy blossomed with the setting up of its first branch at
Mumbai during the year 1987-88. The turning point came in the year 1989 when it
decided to enter into one of the not only emerging rather potential field too i.e; stock
broking. It added the feather of stock broking into its cap. At the same time it became
the member of Hyderabad Stock Exchange through associate firm Karvy securities ltd
and then Karvy never looked back……..it went on adding services one after another, it
entered into retail stock broking in the year 1990. Karvy investor service centers were
set up in the year 1992. Karvy which already enjoyed a wide network through its
investor service centers, entered into financial product distribution services in the year
1993. One year more and Karvy was now dealing into mutual fund services too in the
year 1994 but it didn’t stopped there, it stepped into corporate finance and investment
banking in the year 1995.

Karvy’s strategy has always been being the first entrant in the market. Karvy again hit
the limelight by becoming the first registrar in the country to be awarded ISO 9002 in
the year 1997. Then it stepped into the other most happening sector i.e; IT enabled
services by establishing its own BPO units and at a gap of just 1 year it took the path of
e-Business through its website www.Karvy.com . Then it entered into insurance services
in the year 2001 with the launch of its retail arm “Karvy- the finapolis: your personal
finance advisor”. Then in the year 2002 it launched its PCG(Private Client Group) which
looks after its High Net worth Individuals .and maintain their portfolio and provides
them with other financial services. In the year 2003, it commenced secondary debt and
WDM trading.

It was a decade which saw many Indian companies going global…..so why the largest
financial service provider of India should lag behind? Hence, Karvy launched “Karvy
global services limited” after entering into a joint venture with Computershare, Australia
in the year 2004.the year 2004 also saw Karvy entering into commodities marketing
through Karvy comtrade.

Year 2005 saw Karvy establishing a separate branch for its insurance services under the
head “ Karvy insurance broking ltd” and in the same year, after being impressed with the
rapid growth of Karvy stock broking limited, PCG group of Hong Kong acquired 25%
stake at KSBL. In the year 2006, Karvy entered into one of the hottest sector of present
time i.e real estate through Karvy realty & services (India) ltd. Hence, we can see now
Karvy being established as the largest financial service provider of the country.

Now Karvy group consists of 8 highly renowned entities which are as follow:

1. : The first securities registry to receive ISO 9002 certification in

India. Registered with SEBI as Category I Registrar, is Number 1 Registrar in the
Country. The award of being ‘Most Admired’ Registrar is one among many of the
acknowledgements we received for our customer friendly and competent services.

2. : Karvy stock broking ltd. Consists of five units namely stock

broking servics, depository participant, advisory services, distribution of financial
products, advisory services and private client goups.

3. : it is registered with SEBI as a category 1 merchant banker. Its

clientele includesinclude leading corporates, State Governments, foreign institutional
investors, public and private sector companies and banks, in Indian and global markets.

4. : Karvy insurance broking ltd is also a part of Karvy stock broking

ltd. At Karvy Insurance Broking Limited both life and non-life insurance products are
provided to retail individuals, high net-worth clients and corporates.

5. : The company provides investment, advisory and brokerage
services in Indian Commodities Markets. And most importantly, it offer a wide reach
through our branch network of over 225 branches located across 180 cities.

6. : Karvy Global is a leading business and knowledge process

outsourcing Services Company offering creative business solutions to clients globally. It
operates in banking and financial services, inurance, healthcare and pharmaceuticals,
media , telecom and technology. It has its sales and business development office in New
York, USA and the offshore global delivery center in Hyderabad, India

7. : Karvy Realty (India) Limited is engaged in the business of real

estate and property services offering:

• Buying/ selling/ renting of properties

• Identifying valuable investments opportunities in the real estate sector
• Facilitating financial support for real estate and investments in properties
• Real estate portfolio advisory services

8. : it is a joint venture between Computershare, Australia and Karvy

Consultants Limited, India in the registry management services industry.

Organization structure of Karvy:

talking about the organization structure of Karvy, we have the board of directors as the supreme
governing body , the chairman being Mr. C Parthasarthy, Mr. M Yugandhar as the managing
director, Mr. M S Ramakrishna and Mr. Prasad V. Potluri as directors.

The board of diretors head the Karvy group, Karvy computershares limited, Karvy investors
services ltd., Karvy comtrade, Karvy stock broking ltd., and Karvy global services ltd.

Karvy group being the flagship company looks after the functional departments such as
corporate affairs, group human resources, finance & accounting, training & development,
technology services and corporate quality.

Karvy computershare private limited facilitates mutual fund services, share registry and issue
registry whereas merchant banking is looked after by Karvy investor services ltd. Karvy stock
broking ltd heads its another branch too ie. Karvy insurance broking ltd. The services offered by
KSBL are: stock broking, depository, research, distribution, personal client group and
institutional desk. And finally the BPO services are managed by Karvy global services ltd.
Summarizing it in a diagram, it can be presented as:

Spectrum of services offered by Karvy:

Karvy being the top registrar and transfer agent, functions as registrar in most of the issues in the
country. Talking about the mutual fund services offered by Karvy, we can get the products of 33
AMCs over here. it deals in both closed ended funds as well as open ended too. Now one must
be thinking why to get the mutual funds from Karvy instead of getting it directly from
AMCs???we have great reasons for it: the first one being ; if we avail the services of Karvy then
we can get the information about all the AMCs and their products at a single place along with
expert recommendations whereas at an AMC we can get information about the products of that
specific AMC only. And the second being wide network of Karvy….nowadays we can find
Karvy offices at remote areas too.

Along with these, Karvy is very well handling the role of depository participant. Being
registered with both the depositories i.e.; NSDL (national securities depository ltd) and CDSL
(central depository services ltd), Karvy can have access to both. Its wide network also facilitates
it in distribution of retail financial products.

Karvy believes in being updated always. So it is always ready to use latest technologies so that
its clients always be in touch with the latest happenings along with Karvy. It offers e-business
through internet through its website: www.Karvy.com . Other than it, it also provides its various
services through SMSes.

Karvy’s services are not limited to its investors only rather its offerings are for its corporate
clients and distributors too. it is very well aware of the fact that in this era of neck to neck
competition, we cant ignore any of the aspects of our business….so there’s a offering for
everybody…everyone’s welcome at Karvy.

Why should investors choose for Karvy?

Excellence is next to nothing….and here at Karvy everybody tries their best to offer excellent
services to its clientele through its offerings maintaining the Karvy culture which includes:

1. Controlled and low cost service culture: Karvy is there to serve its client at the minimum
possible cost. it controls cost by its various cost- cutting techniques and minimization of
avoidable costs.

2. Large volume processing capability: being the largest financial service provider in the
country, it has the unique distinction of operating its activities on a large scale which benefits all
the parties cordially.

3. Adherence to strict time schedule: Karvy knows that time is money and tries it best to finish
the task within the stipulated time schedule.

4. Expertise in coordinating multi-location responses: Karvy has got a wide network and hence
one can find its branches at most of the places in India. Thus it enjoys its presence everywhere
and coordinates among itself in solving the queries and in responding to any situation.

5.Expertise in managing independent entities such as banks, post-office etc.: the work culture of
Karvy and the ethics followed inside Karvy makes its workforce compatible with everybody, so
the Karvy people establishes good coordination with independent entities too.

6. Pooling of group resources: Karvy group consists of eight subsidiaries, so it can easily pool
up its resources for accomplishment of its goals, whenever needed. The groups can help each
other whenever there are peaks and lows, and even in the case when they have huge targets just
as we saw few years back, Tata group pooling its resources to acquire Corus.

How Karvy achieved it?

The core competency of Karvy lies in the following points due to which it enjoys a competitive
edge over its competitors. The following culture adopted by Karvy makes it all time favorite
among its clientele:

1. Professionally managed by qualified and trained manpower.

2. Uniquely structured in-house software and hardware department

3. Query handling within 48 hrs.

4. Strong secretarial, accounting and audit systems.

5. Unique work culture of working 7 days a week in 3 shifts.

6. Unmatched network spreading all over India.

How Achievements sounds synonymous to Karvy:

The landmarks achieved by Karvy very well define its success story. In the previous
pages, we learnt how a company started by five chartered accountants, named as Karvy
and company turned into today’s Karvy group, the largest financial intermediary of
India. But success didn’t came to Karvy at a flow, the hard work and dedication of its
workforce made it what it is today…gradually it achieved the following landmarks and
now it has became what we call the Karvy group, now it is:

1.Largest independent distributor for financial products.

2.Amongst the top 5 stock broker.

3.Among the top 3 depository participants.

4.Largest network of branches & business associates.

5.ISO 9002 certified operations by DNV.

6.Amongst top 10 investment bankers.

7.Judged as one of the top 50 IT users in India by MIS south Asia.

8.Full- fledged IT driven operation.

9.India’s no.1 registrar & securities transfer agent.

Clientele of Karvy:

Karvy’s culture has helped Karvy in achieving such a distinct position in the market where it can
boast of its huge client base. Be it a retail investor investing Rs. 500 in a SIP in Reliance mutual
fund or be it the largest corporate house of the country: Reliance industries- everybody is
heading towards Karvy for their wealth maximization, lets have a look at the clientele of Karvy :

According to the datas published in year 2007, Karvy stock broking ltd. Operates
through more than 12000 terminals, more than 290000 accounts are maintained and
commands over 3.14% market share of NSE. The distribution services has access to
more than Rs. 40 billion Assets Under Management. Karvy being a depository
participant with both NSDL and CDSL, manages more than 700000 accounts from more
than 380 locations. Talking about the registry services, it manages over 750 public/ right
issues.at the same time, it is managing over 16 million portfolios as registrar.
If we took a look at some of the top corporate houses availing the services of Karvy then we
have: Reliance, IOC, IDBI,LIC, Hindustan Unilever, Principal Mutual Fund, Duetsche Mutual
Fund, Yogokawa, Marico Industries, Patni Computers, Morgan Stanley, Glenmark, CRISIL, 3M,
Kotak Mahindra Bank, Bharti Televenture, Infosys Technologies, Wipro, Infotech, IPCL,TATA
consultancy services, UTI mutual fund etc. Thus in total Karvy serves over 16 million investors
and 300 corporates.

Hierarchical Structure in diagram:

The above diagram shows the hierarchy of Karvy stock broking ltd. It can be easily depicted
from the diagram that the regional head (presently Mr. Alok Chaturvedi) is the supreme in the
eastern region, under whom the various zonal heads operate and under these zonal heads, the
branch heads operate. Between each level o the hierarchy, there exists a coordinator, who acts as
the facilitator between the different heads.

Karvy at Pune:

Now if we look at Karvy’s branch offices at Pune, then there exist ten branches of Karvy at
Pune, which are as follow:

1. Law College Road

2. Akurdi

3. Aundh

4. Bibvewadi

5. Chinchwad

6. Paud Road

7. Shrinath Plaza

8. Wanowarie

Structure according to the Products offered by Karvy:


Realty n

Insura Stock Deposi Merch

Mutua nce comm tory ant &
l funds brokin odities
g partici inv.ba PMS
g pant nking

Derivative is a product whose value is derived from the value of one or more basic
variables, called bases (underlying assets index) in a contractual manner. The underlying assets
can be Equity, Forex, commodity or any other assets.

There are mainly three types of Derivatives:- Forwards, futures, and Option A forward
contract is a customized contract between two entities, whereas settlement takes place on a
specified date in the future at today’s agreed price.

A future contract is an agreement between two parties to buy or sell an asset at a certain
time in the future at a certain price. Futures contracts are special types of forward contracts in
the sense that the former are standardized exchange-traded contracts.

Options are of two types:- Calls and puts option.

A call option gives the buyer the right to buy a certain asset within a fixed period of time
but not the obligation on to buy.

A put option gives the buyer the right to sell a particular asset at a fixed period of time
but not the obligation to sell it.

Hedging is nothing but to control or eliminate the risk to a certain extent.

Derivatives is an important tool to hedge the risk or position by dint 0f Future & option

My entire project report revolves around Derivatives as a tool of Hedging.

This project has been conducted at Karvy., Pune to the best of my effort and determination.


Research Methodology


Primary :

1) To understand about derivatives market,

2) To study how does a derivative hedge the risk or position.
3) To know why derivatives is considered safer than cash market.

Secondary :

i) To provide better advice to the clients of Motilal Oswal Securities Ltd.

in F & O.
ii) To understand the scope of derivatives in capital market.

Research Approach

1) Study and observance

Data collection:

1) Primary Data : - Formal and informal Discussion with Company guide

and clients of the company.

2) Secondary Data : - Internet, Books, Newspapers, TV Channels, News

Research Problem:

There are very few ways for hedging price risk or price volatility in equity
markets and derivatives is one of them. My study is to see how derivatives
are used for hedging price risk in equity market.


1) As research required a detail information of portfolios of clients, which is

very confidential for the client, a huge difficulty was faced in getting the
2) Also the data used in the research may suffer from incorrectness.
3) As the company guide was very busy in her exhausting work schedule, very
less guidance was available.

Scope of Study

• As derivatives is a very vast subject the scope of research is limited to the

financial derivatives viz. futures & options.
• Forwards has been kept out of the scope of this research
• Since options are widely used for hedging, only the options cases have
been taken into the consideration in my research.
Sample Size : 11




Derivative is a product whose value is derived from the value of one or more
basic variables, called bases (underlying assets, index) in a contractual manner. The
underlying assets can be Equity, Forex, commodity, Bullion or any other assets.

The emergence of the market for derivative products, most notably forwards,
Futures and Option, can be traced 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 derivatives products, it is possible to partially or
fully transfer price risks by locking in asset price.

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 derivative. The price of this derivative is driven by the spot price of
wheat, which is the “underlying”.

The financial derivatives came into spotlight in 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
third of total transactions in the derivatives products.

In recent years, the market for financial derivatives has grown tremendously
both in terms of variety of instruments available, their complexity and also

The factors generally attributed as the major driving force behind growth of
financial derivatives are:

a) Increased volatility in asset prices in financial markets.

b) Increased integration of national financial markets with the international
c) Marked improvement in communication facilities and sharp decline in
their costs.
d) Development of more sophisticated risk management tools, providing
economic agents a wider choice of risk management strategies.
e) Innovations in the derivatives markets, which optimally combine the risks
and returns over a large number of financial assets, leading to higher
returns, reduced risks as well as financial costs as compared to individual
financial assets.

Participants : - The following three broad categories of participants hedgers,

speculators and arbitrageurs trade in the derivatives market.

Hedgers- face risk associated with the price of an asset. They use futures and
options market to reduce or eliminate this risk.

Speculators – wish to bet on future movements in the price of an asset. Future and
Option contracts can give them an extra leverage, that 19s they can increase both
the potential gains and potential losses in a speculative venture.

Arbitrageurs – are in business to take advantage of a discrepancy between prices

in two different markets. If, for instance they see the future price of an asset getting
out of line with the cash price, they will take offsetting positions in the two markets
to lock in a profit.

Types of Derivatives: - The most commonly used derivatives contracts are
forwards, futures and options. Here I took a brief look at various derivatives
contracts that have come to be used: -

Forwards: - A forward contract is a customized contract between two entities,

where settlement takes place on a specified date in the future at today’s pre-agreed

Futures: - A future contract is an agreement between two parties to buy or sell an

asset at a certain time in the future at a certain price. Future contracts are special
types forward contracts in the sense that the former are standardized exchange
traded contracts.

Options: - Options are of two types- Calls and Puts. Call gives the buyer the right
but not the obligation to buy a given quantity of the underlying assets, at a given
price on or before a given future date. Put gives the buyer (holder) the right but not
the obligation to sell a given quantity of the underlying asset at a given price on or
before a given date.

Warrants: - Option generally has live s of upto one year, the majority of options
traded on options exchanges having maximum maturity of nine months. Longer-
dated options are called warrants and are generally traded over the counter.

Leaps: - The acronyms LEAPS means Long term Equity Anticipation Securities.
These are options having a maturity of upto three years.

Baskets: - Baskets options are option on portfolios of underlying assets. The

underlying asset is usually a moving average or a basket of assets.

Swaps: - Swaps are private agreement between two parties to exchange cash flows
in the future according to a prearranged formula. They can be regarded as portfolios
of forward contracts. The two commonly used swaps are;-

a) Interest Rate Swaps

b) Currency Swaps


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 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: -

a) They are bilateral contracts and hence exposed to counter party risk.
b) Each contract is custom designed, and hence is unique in terms of contract
size, expiration date and the asset type and quality.
c) The contract price is generally not available in public domain.
d) On the expiration date, the contract has been settled by delivery of the
e) If the party wishers to reverse the contract, he has to compulsory go to the
same counterparty, which often results in high prices being charged.

Forward Contracts are very useful in hedging and speculating.

The classic hedging application would be that of an exporter who expects to

receive payment in dollar three months later. He is exposed to the risk of exchange
rate fluctuations. By using the currency forward market to sell dollars forward, he
can lock on to a rate today and reduce his uncertainties. Similarly an importer who
is required to make a payment in dollars two months hence can reduce his exposure
to exchange rate fluctuation by buying dollar forward.

Despite it Forward Market world-wide are afflicated by several problems: -

 Lack of centralization of trading,

 Illiquidity, and
 Counterparty Risk.



“A future contract can be defined as a standardized agreement between the

buyer and seller in terms of which the seller is obligated to deliver a specified
asset to the buyer on a specified date and the buyer is obligated to pay the seller
then prevailing future price in exchange of the delivery of the asset”.
Parties Involved:

4) Buyer of the asset.

5) Exchange.
6) Seller of the asset.

The 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 specified certain standard features
of the contract. It is a standardized contract with standard underlying instrument,
a standard quantity and quality of the underlying instrument that can be delivered
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.

Futures Terminology

b) Spot Price: - The price at which an asset trades in the spot market.

c) Futures Price: - The price at which the futures contract trades in the futures

d) Contract Cycle: - The period over which a contract trades. The index future

contracts on the NSE have one month, two month and three month expire
cycles. Which expire on the last Thursday of the month.
e) Expiry Date: - It is the date specified in the futures contracts. This is the last

date on which the contract will be traded at the end or which it will cease to
f) Contract Size: - The amount of asset that has to be delivered under one

g) Basis: - In the context of financial futures, basis can be defined on the future

price minus the spot price. There is a different basis for each delivery month
for each contract. In a normal market basis is positive.
h) 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.

i) Initial Margin: - The amount that must be deposited in the margin account at
the time of a futures contract is first entered into is known as initial margin.
j) Marking to Market: - In the futures market at the end of each trading day the

margin account in adjusted to reflect the investor’s gain or loss depending

upon the futures closing price. This is called marking to market.
k) 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.

Trading in Futures Segment

It is traded basically on NSE. Unlike cash segment, a certain margin in

paid is futures segment. It operates in T+1 basis. Margins are pre-decided as per
the lot size. This is very useful for those investors, who do not have entire amount
to invest. In future contracts they pay only a certain margin and enter into trading.

For instance, Mr.X, who trades in cash market, wishes to buy 650 shares of
Patni @ Rs.350/- share. For this he will have to invest (650 x 350) =
Rs.2,27,500/- But he does not have this much amount to invest.

Now in future market, he will buy one July lot (650 shares) of Patni by
paying a premium around only 15% of total amount. In this case the total cost of
Mr.X for 1 lot of Patni will be only Rs.34,125/-.

The main drawback of this trading in that it acts in T+1 basis, means a
trader has to settle his position every day, until he closes his trading in particular

Risk also can be hedged in futures market by imposing “Stop Loss”

Stop Loss: - This facility allows to the investors to release an order into the
system, after the marker price of the security reaches or crosses a threshold price,
called trigger price.

For Example:

Mr.X bought 1 July lot of Cipla @ Rs.320/- per share by paying 15%
margin. However he does not want to take any risk of downward movement, he
imposed a stop loss at @ Rs.310/- share.

In this case Mr.X made his loss limit by Rs.10/- per share, however he can
fetch unlimited profit as price keeps going up.



“Option is a legal contract in which the writer of the option grants to the buyer,

the right to purchase from or sell to the writer a designated instrument or a scrip

at a specified price within a specified period of time”.

Parties Involved

1) Buyer of the asset

2) Exchange

3) Seller of the asset

Options are fundamentally different from forward and futures contracts.

An option gives the holder of the option the right to do something. The holder
does not have to exercise this right. In contrast, in a forward or futures contract,
the two parties have committed themselves to doing something.

There are basically two types of options

a) Call Option
b) Put Option

A call option gives the holder the right but not obligation to buy an assets
by a certain date for a certain price. For instance X purchases a call option from Y
of REL it means Y gives the right to purchase REL at a fix strike price within a
certain period.

Where as a put option gives the holder the right but not the obligation to
sell an asset by a certain date for a certain price.

Options terminology

a) Index option: 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.
b) Stock option: Stock options are options on individual stocks. Options

currently trade on over 500 stocks in the United States. A contract givens
the holder the right to buy or sell shares at the specified price.
c) Buyer of an option: The buyer of an option is the one who by paying the

potion premium buys the right but note the obligation to exercise his
option on the seller/writer.
d) 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 wishes to exercise his option.
e) Option price: Option price is the price which the option buyer pays to the

option seller. It is also referred to as the option premium.

f) Expiration date: The date specified in the options contract is known as

the expiration date, the exercise date, the strike date or the maturity.
g) Strike price: The price specified in the options contract is known as the

strike price or the exercise price.

h) American options: American options are options that can be exercised at

any time upto the expiration date. Most exchange-traded options are
i) European options: European options are options that can be exercised
only on the expiration date itself.
j) In-the-money option: A call option on the index is said to be in-the-
money when the current value of index stands at a level higher than the
strike price (i.e. spot price > strike price).
k) 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 value of current index equals the
strike price (i.e. spot price = strike price).
l) Out-of-the-money option: An out-of-money (OTM) option is an option
that would lead to a negative cash flow it was exercised immediately. A
call option on the index is said to be out-of-the-money when the value of
current index stands at a level which is less than the strike price (i.e. spot
price < strike price).

Distinction between futures and options:

Futures Options
Exchange traded, with novation Same as futures
Exchange defines the product Same as futures
Prices is zero, strike price moves Strike price is fixed, price moves.
Price is zero Price is always positive.
Linear payoff Non-linear payoff.
Both long and short at risk Only short at risk.

Since hedging is mostly done by means of option nowadays. There are certain
strategies which are considered before hedging the positions or risks by the
investors: -

Option Strategies

a) Long Call: - A long call can be an ideal tool for an investors who wishes

to participate profitably from an upward price movement in the underlying

stock .
b) Long put: - A long put can be an ideal tool for an investor who wishes to

participate profitably from a downward price move in the underlying

c) Married Put: - An investor purchasing a put while at the same time

purchasing an equivalent number of shares of the underlying stock is

establishing a “married put” position- a hedging strategy with a name from
an old IRS ruling.
d) Protective Put: - An investor who purchases a put option while holding

shares of the underlying stock from a previous purchase is employing a

“protective put”.
e) Covered call: - The covered call is a strategy in which an investor writes a

call option contract while at the same time owning an equivalent number
of shares of the underlying stock. If this stock is purchased simultaneously
with writing the call contract, the strategy is commonly referred to as a
“buy-write.” If the shares are already held from a previous purchase, it is
commonly referred to an “overwrite”.
f) Cash Secured Put: - According to the terms of a put contract, a put writer

is obligated to purchase an equivalent number of underlying shares at the

put’s strike price if assigned an exercise notice on the written contract.
Many investors write puts because they are willing to be assigned and
acquire shares of the underlying stock in exchange for the premium
received from the put’s sales. For this discussion, a put writer’s position

will be considered as “cash-secured” if he has on deposit with his
brokerage firm a cash amount (or equivalent) sufficient to cover such a
purchase of all option contract.
g) Bull Call spread: - Establishing a bull call spread involves the purchase of

a call option on a particular underlying stock, while simultaneously writing

a call option on the same underlying stock with the same expiration month,
at a higher strike price. Both the buy and the sell sides of this spread are
opening transactions, and are always the same number of contracts.
h) Bear Put Spread: - Establishing a bear put spread involves the purchase

of a put option on a particular underlying stock, while simultaneously

writing a put option on the same underlying stock with the same expiration
month, but with a lower strike price. Both the buy and the sell sides of this
spread are opening transactions, and are always the same number of
i) Caller: - A collar can be established by holding shares of an underlying
stock, purchasing a protective put and writing a covered call on that stock.
The option portions of this strategy are referred to as a combination.
Generally, the put and the call are both out-of-the-money when this
combination is established, and have the same expiration month.



Hedging in nothing but a mechanism to reduce or control risks involved in

capital market. Various Risk involved in capital market: -

a) Price Risk
b) Liquidity Risk
c) Operational Risk

Hedging plays an important role to combat these risks.

Hedging does not mean to maximize return. It so happens that sometime

despite imposing hedging inventers may fetch unlimited profit in that case hedging
does not bear fruit. Hedging shows its colour only case of losses by limiting it.

In a simple example, a miller may buy wheat that is to be converted into

flour. At the same time, the miller will contract to sell an equal amount of wheat,
which the miller does not presently own, to another trader. The miller agrees to
deliver the second lot of wheat at the time the flour is ready fro market and at the
price current at the time of the agreement. If the price of wheat declines during the
period between the miller’s purchase of the grain and the flour’s entrance onto the
market, there will also be a resulting drop in the price of flour. That loss must be
sustained by the miller. However, sine the miller has a contract to sell wheat at the
older, higher price, the miller makes up for this loss on the flour sale by the gain on
the wheat sales.

Terms in Hedging

Long Hedge:
Long hedge is the transaction when we hedge our position in cash market by
going long in derivatives market.

For example, let us assume that we are going to receive funds in the near
future and we want to invest it into the capital market. Also we expect the market to
go up in the near future, which is not desirable for us as we would have to invest
more money. The risk can be hedged by making use of derivatives such as F & O.

Short Hedge:

Short hedge in the hedge accomplished by going short in the derivatives


For example, we have a portfolio which we want to liquidate in the near

future. Meanwhile prices of the scrip may go down, which is not favourable for us.
Thus to protect our portfolio value we can go short in the derivative market.

Cross hedge:

When derivatives of the underlying assets we have, are not available, we use
derivatives on any other related underlying, that are available. This is called as
cross hedge.

Fore example, derivatives on Jet fuel are not available in the market, for
hedging against prices of it we may use crude oil derivatives which are related with
the Jet prices.


Awareness of hedging strategies among clients

After collecting data from clients, it reveals that clients are almost aware about
Long call/put strategy, Protective strategy and married put option strategy.
Number of clients can be shown about awareness of different strategy in
following Bar graph: -



6 Series1

Long call Protective Married Bear call / Covered Caller
/put strategy put option put spread call strategy
strategy strategy strategy strategy

Long Call / Put Strategy

Long Call / Put Strategy


Protective Strategy

Protective Strategy


Married Put Option

Married Put Option


Bear Call / Put Option Strategy


Bear Call / Put Option



Covered Call Strategy


Covered Call Strategy


Analysis and Interpretation

Case I

Mr. Bhandari bought 675 shares of Tisco few days before the budget @ Rs.350/-

per share, as general expectation from the budget was that it will be an

infrastructure of development focused budget. He was also bullish on Tisco.

However Mr. Bhandari wanted to hedge against any downward movement

of Tisco in the Market.


There are following Alternatives for Mr.Bhandari to hedge his position

i) Long put strategy
ii) Protection put strategy
iii) Bear put spread strategy

Since Mr.Bhandari has to protect his 675 shares of Tisco so in this case, to hedge

against any downward movement of Tisco, Mr.Bhandari will opt protective put

strategy. So he should buy 1 lot of put option of Rs.350/- strike price @ Rs.10/-

premium at the same time.

Now the total cost of Bhandari is: -

Bought Tisco @ Rs.350/- share = 2,36,250/-

cost of 1 lot of Tisco put option @ Rs.10/- = 6,750/-



S. No. Stock Stock Put Value Cost of Return

Price Value Premium
1 320 2,16,000 20,250 6,750 (6,750)
2 330 2,22,750 13,500 6,750 (6,750)

3 340 2,29,500 6,750 6,750 (6,750)
4 350 2,36,250 0 6,750 (6,750)
5 360 2,43,000 0 6,750 Nil
6 370 2,49,750 0 6,750 6,750
7 380 2,56,500 0 6,750 13,500
8 390 2,63,250 0 6,750 20,250
9 400 2,70,000 0 6,750 27,000

25000 Put Value
20000 20,250 13,500
6,750 0 0
Cost of
5000 Premium 6,750
0 6,750 6,750



6,750 6,750
Return -6,750 -
6,750 -6,750 -
6,750 Nil
370 380 390 400

6 7 8 9


1) The stock value is arrived at as (stock value x 675 shares).

2) If the stock price is below Rs.350/- in the spot market, the put option will

be executed. Thus put value is arrived at as

(strike price – stock price) x 675

3) If the stock price goes below from Rs.360/- loss is limit to the extent of its

premium amount (Rs.10/-), or Rs.6750/-.

4) If the stock price goes up from Rs.360/- it can fetch unlimited profit as

stock price keeps going up.

Case II

Mr.Bhalgat was mildly bullish on Bank of India. He already got 1900 shares of

Bank of India @ rs.110/- Shares few days back. Though Mr.Bhalgat, bullish on

Bank of India, wanted to hedge against any downside movement of Bank of India

due to budget related volatility.


That time Bank of India was trading around Rs.120 – 130 range.

There are following Alternatives for Mr.Bhalgat to hedge his position

iv) Long put strategy

v) Protection put strategy
vi) Bear call spread strategy

Since Mr. Bhalgat is mildly bullish on BOI, he will opt Bull call spread

strategy as the best strategy, following things might be suggested –

a) Buy a July call option of Bank of India for 1 lot of strike price Rs.120/-

shares, at a premium of Rs.12/- share.

b) Sell a July call option for one lot of Bank of India Rs.140/- strike price at a

premium of Rs.2/- shares.


Buying 1 lot of call option of BOI

(1900 x 12) = 22,800/-

( – ) selling 1 lot of call option of BOI

(1900 x 2) = 3,800/-



S. No. Stock Stock Bought Sold Cost of Return

Price Value Call Call Premium
Value Value

1 90 1,71,000 0 0 19,000 (19,000)
2 100 1,90,000 0 0 19,000 (19,000)
3 110 2,09,000 0 0 19,000 (19,000)
4 120 2,28,000 0 0 19,000 Nil
5 130 2,47,000 19,000 0 19,000 19,000
6 140 2,66,000 38,000 0 19,000 38,000
7 150 2,85,000 57,000 19,000 19,000 38,000
8 160 3,04,000 76,000 38,000 19,000 38,000


1) Stock price is arrived at as (stock price x 1900)

2) At any price above Rs.120/- shares bought call value is arrived at as

{(stock price – 120 ) x 1900}.

3) At any price above Rs.140/- share, sold call value is arrived at as {(stock

price – 140 ) x 1900}.

4) Return is maximum loss Rs.19,000 and maximum profit Rs.38,000.

Case III

Mr. Sonagra is a regular mid to long term investor. In the beginning of the month
of the July he had not enough money in hand to invest in shares. He was
supposed to get money at the end of the month.

However he was bearish on Titan. He want to buy Titan but not after few days as
it could lead to a loss of thousands.


Since Mr. Sonagra has not sufficient amount to invest in shares, he will
adopt only Long call strategy to hedge his position.

In such circumstance Mr.Sonagra will buy one lot (800 shares) of call option at a
premium of Rs.10/- per share the strike price of which is Rs.510/-.

Cost for 1 lot of Titan in call option will be

800 x 10 = Rs.8,000/-


Sr. No. Stock price Stock value Cost of Value of call

Premium Option
1 480 3,84,000 8000 0
2 490 3,92,000 8000 0
3 500 4,00,000 8000 0
4 510 4,08,000 8000 0
5 520 4,16,000 8000 10
6 530 4,24,000 8000 20
7 540 4,32,000 8000 30
8 550 4,40,000 8000

i) Though Mr.Sonagra bought a call option of a strike price of Rs.150/-,

he expects that stock price will go up.

ii) No matter how much stock price goes up stock price goes up more he

can fetch profit more, became he can purchase at a fix stock price of


iii) If the stock price goes down, call option will not be executed, because

purchasing a lot in Rs.510/- in downward movement does not sound


iv) In downward movement his loss will be limit to the extent of premium

amount (Rs.8,000).

v) While in upward movement his profit will be unlimit as the price goes

up deducting (premium + strike price).

Case IV

Mr.Pandit was holding 550 shares of Reliance Energy Ltd. (REL), which he had
purchased @ Rs.620. Due to market sentiments and his personal study he was
bearish on REL. In the fear of losing he wanted to hedge against downfall in the
prices of REL. (Lot size = 550)


There are following Alternatives for Mr.Pandit to hedge his position

vii) Long put strategy

viii) Protection put strategy
ix) Bear put spread strategy

Since Mr. Pandit has to protect its 550 shares of REL, In such circumstance
Mr.Pandit will prefer to buy 1 lot of put option at a premium of lets assume
Rs.10/- per share, strike price of which is Rs.620.

Now the total cost of Mr.Pandit will be : -

Buying of 550 shares of REL @ Rs.620/-

(550 x 620) = 3,41,000/-

(+) buying of 1 lot of put opition @ Rs.10/- share

(10 x 550) = 5,500/-



Sr. No. Stock Stock Bought Cost of Return

Price Value Put Value premium
1 590 3,24,500 16,500 5,500 (5,500)
2 600 3,30,000 11,000 5,500 (5,500)

3 610 3,35,500 5,500 5,500 (5,500)
4 620 3,41,000 0 5,500 (5,500)
5 630 3,46,500 0 5,500 Nil
6 640 3,52,000 0 5,500 5,500
7 650 3,57,500 0 5,500 11,000
8 660 3,63,000 0 5,500 16,500
9 670 3,68,500 0 5,500 22,000

6000 Bought Put Value
16,500 11,000
5,500 0 0
Cost of premium
0 5,500 5,500 5,500
3,52,000 3,57,500 3,63,000 5,500 5,500
640 650 660 Return -5,500 -
5,500 -5,500 -
6 7 8 5,500 Nil


i) Stock value is arrived at as (stock price x 550 shares)

ii) If the stock price goes below from Rs.620/- put option is executed. The

put value is arrived at as

( strike price – stock price ) x 550

iii) If the stock price goes below from Rs.630/- (cost price) the loss is limit

to the extent of its premium means Rs.5,500/-.

iv) If the stock price goes up from Rs.630/- of can fetch unlimited profit an

stock price keeps going up and put option will not be executed.



Case I

i) As the stock price goes down value of put option increases.

ii) Break Even point (B.E.P.) for Mr.Bhandari in Rs.360/- share or
iii) Loss in limit to the extent of its premium.
iv) As the stock price goes up value of put option loses its significance.
v) If the put option is not executed till its expiration period it will
automatically repudiate.

Case II

i) As the value of stock price goes up from strike price the bought call
value and sold call value increases.
ii) Rs.120/- share or Rs.2,28,000/- is the Break Even point (B.E.P.) for
iii) Mr.Bhalgat made limit his profit and loss by buying and selling 1 lot of
call option simultaneously.
iv) As the stock price goes down from its strike price the value of call
option loses its significance.

Case III

i) Mr.Sonagra should be quite sure that the value of stock price will
increase in coming future.
ii) He will fetch profit when market will be at bullish by purchasing the
shares @ Rs.510/- share and selling it in more that Rs.520/- in spot
iii) Mr.Sonagra has been given right but not obligation to buy shares @
Rs.510/- in lieu of Rs.10/- per share as premium whatever market
condition may be.
iv) The value of call option become insignificant if stock price goes below
from Rs.510/-.

Case IV

i) As the stock price decreases the value of bought put option increases.
ii) Rs.630/- share or Rs.3,46,500/- is the Break Even point for Mr.Pandit.
iii) As the stock price goes up form its strike price put option become
iv) Here loss is limit to the extent of its premium amount.
v) If the put option is not executed till its expiration period it in
automatically repudiated.



Case I

i) Mr.Bhandari should be very conscious about premium rate and

expiration period before opting put option.

ii) If the stock price starts to decline he should not execute his put option
immediately because in any low cases he will lose Rs.6,750/- while he
may fetch profit in going up of stock price after downward movement.

Case II

ii) Mr.Bhalgat should adopt this strategy only in that case, when he is
quite sure that profit is not possible after a certain extent.

Case III

ii) Mr.Sonagra should buy September call option instead of July call
option, because during this gap stock price must go up.
iii) When stock price reaches up to its highest level he should execute his
call option.

Case IV

i) Mr.Pandit should be very conscious about premium rate and expiration

period of option.
ii) If the stock price starts to decline, he should not execute his put option
immediately, because in any low cases he will lose Rs.5,500/- while he
may fetch profit in going up of stock price after downward movement.

General Suggestion

It is humbly suggested to all the clients of Motilal Oswal Securities

Ahmednagar that they develop their knowledge in future & option market
because it is only the way by dint of which risk or position and they should
always consider the rolling settlement of period.


i) Derivative is the best tool for hedging the position or risk.

ii) Hedging is basically done in option market.

iii) Purchaser of a call option always hopes that the stock price will

go up.

iv) Purchaser of the put option always hopes that stock price will go


v) Strike price and Expiration period plays important role in hedging.

vi) Fund managers use basically use index option to hedge their


vii) Individuals use generally stock option to hedge risks.

viii) Individuals use option in speculative manner.

ix) There is a wide scope of derivatives markets.













journals & other references:

Karvy –the finapolis

Karvy- business associates manual

The Economic Times

Business Standard

The Telegraph

Business India

Fact sheet and statements of various fund houses.