future and options

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CONTENTS

Chapter I Introduction

Need for the study

Objectives of the studyMethodology

Limitations

Chapter II Industry Profile

Stock markets in India

Financial MarketsMoney Markets

Capital Markets

Stock Markets

Derivative Markets

Chapter -III Steel city securities Limited profile .

About the organization

Organization structure

Activities of SCSL

Registration steps

Chapter - IV Theoretical framework of derivative market . Chapter -V Practical aspects of derivative market in Steel City

Securities Ltd.

Chapter - VI Summary and Suggestions .

ANNEXURE Bibliography


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Chapter 1

Overview

Introduction

Need for the study

Objectives of the study

Methodology

Limitations


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INTRODUCTION

India can boast of being one of the oldest stock markets in Asia. Earlier in

the initial days trading in securities was done in a Very informal or Unsystematic

manner Company agents or representatives representing different corporate

Companies, already listed in the Stock Exchange. These representatives has to

openly outcry the necessary details about the company and give a brief description of

the number of shares allotted to issue and their quoted prices. After this the bidding

process takes Place.

This system was lacking the information technology for immediate

matching or recording of trades. This was time consuming and inefficient. In order to

provide efficiency, liquidity and transparency, NSE(National Stock Exchange)

introduced a nation wide online fully automated screen based trading system(SBTS)

where a member can punch into the computer Quantities of securities and the prices at

which he likes to transact and the transaction is executed as soon as it finds matching

sell or buy orders from a Counter party.

Today India can boast that almost 100% trading takes place throughElectronic order matching. NSE has main computer which is connected through Very

Small Aperture Terminal (VSAT) installed at its office. Brokers have terminals

(identified as PCs) installed at their premises which are connected through VSATS/

Leased Lines/ Modems.

With the emergence of online trading in Indian Stock Exchanges the volume

of the securities traded, the size of the market and the market turnover has increasedtremendously. This accounts for about 2/3 rd of the National Income of the Economy.


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DERIVATIVES MARKET IN INDIA

Derivatives products initially emerged as hedging devices againstfluctuations in underlying asset. In recent years the market for financial derivatives has

grown tremendously in terms of variety of instruments available and it marks by a

very high volatility. Futures and options on stock indices have gained more popularity

than on individual stocks. Through the use of derivatives products it is possible to

partially (or) fully transfer price risks by locking in asset prices.

NEED FOR THE STUDY

Performance Evaluation makes the reader understand about the performance

of the particular scrips since last 2months.

My study can make the investor understand various operations done in Stock

Exchange.

This gives them a clear idea about the performance of the scrips and how and

where to invest.

After going through my study the reader can be very well benefited by not only

knowing about Stock Exchange but also its operation, various guidelines and

by learning the performance on scrips.


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OBJECTIVES

To study various operations of various Stock Exchange in India.

To study the fluctuations of selected scrips that is traded regularly in NSE and

suggestions given.

To study the derivatives trading in the Indian Capital Market.

To study the Futures and forwards contract in the derivative markets.

To study the factors which determine or influence the Option price.

To study about Futures and Options as a hedging tools.

To study clearing and Settlement procedure of Futures and Options.

To study the payoff for Future and Options in the long and short run.

METHODOLOGY

The study was under taken in the trading floor of SCSL. The Information

regarding the online trading is collected from both primary as well as secondary

sources of data.

Primary data

Watching the online trading live.

Interacting with the operators at the computer terminals the clients trading in

SCSL.

Collecting information from the head of each department and from the staff

working in those departments.


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Secondary data

Collecting the data from the website of NSE.

Referring the topics in textbooks and journals relating to stock exchange

operations.

Collecting information through internet and also from Steel City Securities

Limited.

LIMITATIONS

As the subject chosen comparatively new one, the study suffers from

certain limitations.

1. Stock Exchange is an ocean and study is an attempt to understand which a drop in

the ocean. The activities in stock exchange and derivatives market are vast and to

understand all the activities is a difficult task, as there are only few persons who can

provide information.

2. To know the entire activities of stock exchange is very difficult as it takes

a long period to understand.

3. Though the system, people and time were there, some information regarding certain

topics in stock trading was not collected due to non availability of time to the key

persons from their busy schedule.

4. Because of the comprehensive nature of some information is not disclosed though

sources of information are available.


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Chapter 2

Overview

Industry Profile

Stock markets in IndiaFinancial Markets

Money Markets

Capital Markets

Stock Markets

Derivative Markets


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INTRODUCTION TO FINANCIAL MARKETS

Finance is the integral part of modern business. Financial markets refer to

the institutional arrangements for dealing in financial assets and credit instruments of

different types, such as currency cheques, bank deposits bills, etc.

The main functions of the financial markets are:(i) To facilitate creation and allocation of credit and liquidity

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

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

(iv) To provide financial convenience;

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

TYPES OF FINANCIAL MARKETS:

Based on credit requirement for short-term and long-term purposes,

financial markets are divided into two categories:

1. Money Market

2. Capital Market


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Financial Management

Financialinstitutions

FinancialMarkets

FinancialInstruments

FinancialServices

Money Market Capital Market

UnorganizedOrganized

Stock Market Term Lending Institutions

Gift edged Securitiesmarket Industrial securitiesmarket

Primary market

Secondary market

Stock Exchange

NSE BSE OTCEI OTHERS

Wholesale debt market segmentCapital Market Segment

Cash Segment Derivative segment

OptionFuture Interest


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STOCK EXCHANGES IN INDIA

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

India. Among the 18 stock exchanges, the first organized stock exchange set up at

Bombay in 1857 is distinguished not only by its size but also it has been recognized

permanently, while the recognition for other markets is renewed every 5 years. Stock

markets are organized either as voluntary, non-profit making associations (Bombay,

Ahmedabad, Indore) or public limited companies (Calcutta, Delhi, Bangalore) or

company limited by guarantee (Madras, Hyderabad).

In India, the growth of stock exchanges has been linked to the growth of

corporate sector. Though a number of stock exchanges were set up before

independence but, there was no All India legislation to regulate theyre working.

Every stock exchange followed its own methods of working .To rectify this situation,

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

In 1965, 22 separate provincial stock exchanges were merged into 3 regional

stock exchanges and in 1973 these, in turn, were combined to form the National Stock

Exchange (NSE) under the title of the stock exchange that has trading floors in many

former provincial center. At present, there are 26 stock exchanges in our country. The

over-the counter exchange of India began its operations in 1992. Since 1995, trading

in securities is screen based (on-line)

BOMBAY STOCK EXCHANGE (BSE):

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

Bombay in 1857. It is the premier or apex stock exchange in India as it is

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

recognition of other stock exchanges is renewed every 5 years. It is the oldest stock

market.


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Bombay Stock Exchange raised the threshold limit for listing to Rs.10

crores, moved on to weekly settlement and quicker actions for each settlement.

Settlement is through the clearinghouse . 12 days carry forward is allowed on BSE.

Index in BSE is SENSEX. BSE membership fee in 1857 was just Rs1lakh and now it

in about Rs 2crores.

NATIONAL STOCK EXCHANGE (NSE)

National Stock Exchange of India Ltd was started in 1992 with a paid-

up equity of Rs.25 crores. The government recognized it in the same year and NSE

started its operations in wholesale in Nov 1994.

NSE MISSION NSE mission is setting the agenda for change in the securities markets in

India.

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

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

and hybrids,

ensuring equal access to investors all over the country through an appropriate

communication network,

providing a fair, efficient and transparent securities market to investors using

electronic trading systems,

enabling shorter settlement cycles and book entry settlements systems, and

meeting the current international standards of securities markets.

NSE LOGO

The logo of the NSE symbolizes a single nationwide securities trading facilityensuring equal and fair access to investors, trading members and issuers all over the


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country. The initials of the Exchange viz., N, S and E have been etched on the logo

and are distinctly visible. The logo symbolizes use of state of the art information

technology and satellite connectivity to bring about the change within the securities

industry. The logo symbolizes vibrancy and unleashing of creative energy to

constantly bring about change through innovation.

NSE GROUP

NSCCL

NCCL NSETECH

IISL

DotEx Intl. Ltd.

NSE.IT
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NSE Milestones

November 1992 Incorporation

April 1993 Recognition as a stock exchange

May 1993 Formulation of business plan

June 1994 Wholesale Debt Market segment goes live

November 1994 Capital Market (Equities) segment goes live

March 1995 Establishment of Investor Grievance Cell

April 1995 Establishment of NSCCL , the first Clearing Corporation

June 1995 Introduction of centralised insurance cover for all trading members

July 1995 Establishment of Investor Protection Fund

October 1995 Became largest stock exchange in the country

April 1996 Commencement of clearing and settlement by NSCCL

April 1996 Launch of S&P CNX Nifty

June 1996 Establishment of Settlement Guarantee Fund

November 1996Setting up of National Securities Depository Limited , first depository inIndia, co-promoted by NSE

November 1996 Best IT Usage award by Computer Society of India

December 1996 Commencement of trading/settlement in dematerialised securities

December 1996 Dataquest award for Top IT User

December 1996 Launch of CNX Nifty Junior

February 1997 Regional clearing facility goes live

November 1997 Best IT Usage award by Computer Society of India

May 1998Promotion of joint venture, India Index Services & Products Limited(IISL)

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

July 1998 Launch of NSE's Certification Programme in Financial Market

August 1998 CYBER CORPORATE OF THE YEAR 1998 award

February 1999 Launch of Automated Lending and Borrowing Mechanism

April 1999 CHIP Web Award by CHIP magazine

October 1999 Setting up of NSE.IT

January 2000 Launch of NSE Research Initiative

February 2000 Commencement of Internet Trading

June 2000 Commencement of Derivatives Trading ( Index Futures )

September 2000 Launch of 'Zero Coupon Yield Curve'

November 2000Launch of Broker Plaza by Dotex International, a joint venture betweenNSE.IT Ltd. and i-flex Solutions Ltd.

December 2000 Commencement of WAP trading
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June 2001 Commencement of trading in Index Options

July 2001 Commencement of trading in Options on Individual Securities

November 2001 Commencement of trading in Futures on Individual Securities

December 2001 Launch of NSE VaR for Government Securities

January 2002 Launch of Exchange Traded Funds (ETFs)

May 2002NSE wins the Wharton-Infosys Business Transformation Award in theOrganization-wide Transformation category

October 2002 Launch of NSE Government Securities Index

January 2003 Commencement of trading in Retail Debt Market

June 2003 Launch of Interest Rate Futures

August 2003 Launch of Futures & options in CNXIT Index

June 2004 Launch of STP Interoperability

August 2004 Launch of NSEs electronic interface for listed companies

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

June 2005 Launch of Futures & options in BANK Nifty Index

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

January 2007 Launch of NSE CNBC TV 18 media centre

March 2007 NSE, CRISIL announce launch of IndiaBondWatch.com

June 2007 NSE launches derivatives on Nifty Junior & CNX 100

October 2007 NSE launches derivatives on Nifty Midcap 50

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

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

April 2008 Launch of India VIX

April 2008 Launch of Securities Lending & Borrowing Scheme

August 2008 Launch of Currency Derivatives

August 2009 Launch of Interest Rate Futures

November 2009 Launch of Mutual Fund Service System

December 2009 Commencement of settlement of corporate bondsFebruary 2010 Launch of Currency Futures on additional currency pairs

March 2010 NSE- CME Group & NSE - SGX product cross listing agreement

April 2010 Financial Derivative Exchange of the Year Award' by Asian Banker

July 19, 2010 Commencement of trading of S&P CNX Nifty Futures on CME

July 19, 2010 Real Time dissemination of India VIX.

July 28, 2010 LOI signed with London Stock Exchange Group

October 12, 2010 Introduction of Call auction in Pre-open session

October 28, 2010 Introduction of European Style Stock Options

October 29, 2010 Introduction of Currency Options on USD INR
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NSE Technology

Across the globe, developments in information, communication andnetwork technologies have created paradigm shifts in the securities market operations.

Technology has enabled organisations to build new sources of competitive advantage,

bring about innovations in products and services, and to provide for new business

opportunities. Stock exchanges all over the world have realised the potential of IT and

have moved over to electronic trading systems, which are cheaper, have wider reach

and provide a better mechanism for trade and post trade execution.

NSE believes that technology will continue to provide the necessary impetus

for the organization to retain its competitive edge and ensure timeliness and

satisfaction in customer service. In recognition of the fact that technology will

continue to redefine the shape of the securities industry, NSE stresses on innovation

and sustained investment in technology to remain ahead of competition. NSE IT set-up

is the largest by any company in India. It uses satellite communication technology to

energies participation from around 400 cities spread all over the country. In the recent past, capacity enhancement measures were taken up in regard to the trading systems so

as to effectively meet the requirements of increased users and associated trading loads.

With up gradation of trading hardware, NSE can handle up to 1 million trades per day.

CIRCUIT BREAKERS

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

INDEX-BASED MARKET-WIDE CIRCUIT BREAKERS

The S & P CNX The index-based market-wide circuit breaker system applies at

3 stages of the index movement, either way viz. at 10%, 15% and 20%. These circuit

breakers when triggered bring about a coordinated trading halt in all equity and equityderivative markets nationwide. The market-wide circuit breakers are triggered by


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movement of either the BSE Sensex or the NSE S&P CNX Nifty, whichever is

breached earlier.

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

hour market halt if the movement takes place before 1:00 p.m. In case the

movement takes place at or after 1:00 p.m. but before 2:30 p.m. there would be

trading halt for hour. In case movement takes place at or after 2:30 p.m. there

will be no trading halt at the 10% level and market shall continue trading.

In case of a 15% movement of either index, there shall be a two-hour halt if the

movement takes place before 1 p.m. If the 15% trigger is reached on or after

1:00p.m. but before 2:00 p.m., there shall be a one-hour halt. If the 15% trigger

is reached on or after 2:00 p.m. the trading shall halt for remainder of the day.

In case of a 20% movement of the index, trading shall be halted for the

remainder of the day.

S&PCNX NIFTY:

NIFTY is based upon solid economic research it the new world of financial

product on the index like index futures, index options and index funds. A trillions

calculations were expanded to evolve the rules inside the S&P CNX Nifty index.

The result of this work is remarkably simple:

The correct size is to use is 50.

Stocks considered for the S&P CNX Nifty must be liquid by the 'Impact

cost criterion.

The largest 50 stocks that meet the criterion go into the index.

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

Low market impact cost


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High edging effectiveness

Chapter 3

OverviewORGANISATION PROFILE

PROFILE OF SCSLHISTORICAL BACKGROUND OF SCSL


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ORGANIZATION STRUCTUREFUNCTIONS OF SCSLDEPARTMENTS IN SCSL

HISTORICAL BACKGROUND OF THE COMPANY:

Confidence As Strong as Steel

Steel City Securities Limited was incorporated on 22 nd February 1995

and raised equity of Rs.105 lakh on 24 th June 1995 and obtained the membership of

the largest and prestigious National Stock Exchange of H-Limited (NSE) and Bombay

Stock Exchange (BSE) in 2000, in its capital market segment. The 1 st VSAT for its


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trading workstation (TWS) at Hyderabad was installed in 1995 and the 2 nd at

Visakhapatnam in April 1996.

Presently, there are 64 VSATS installed at more than 50 centers in Andhra

Pradesh, Orissa, Tamilnadu and Karnataka. There are 219 computer trading terminals put together connected to their VSAT at the centers (each VSAT can have 5 TWS

connected). Since its inception the service of this organization is prompt and there is

not a single instance of payout of funds / deliveries delay to any client, from the

beginning the firm is committed to continue the same service in future also.

Companies basic principle is total commitment in service to all clients with all

transparency and ensures that is it their sacred policy not to indulge in own trading,

there are no self-motives or necessity to cancel or delay anything.

Every branch is fully equipped and independently connected to the NSE

Hub at Mumbai, every branch is having 2 to 5 trading terminals connected to VSAT.

The company performance has not parallel on NSE.

Steel City Securities Ltd. follows a functional organization system. It

provides various services which are provided through different departments. They are:Trading system:

Deals with online trading facility through the VSAT

Registration of clients and interaction with clients

Dealing with new sub brokers and making them conversant with the system

Provides updated information of a days trading activities.

Data Processing:

Opening of the account after the fulfillment of various formalities.

Shares are credited to the De-Mat account by dematerializing the physical

shares and those brought from the secondary market.

The process of settling the selling and buying obligations takes places through

the delivery instruction slip to their respective clients


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Deliveries:

This department acts as an intermediary between stock exchange and clients.

Hence proper knowledge is very essential. Proper records of all inward and outwardstocks should be maintained failing which there may be improper deliveries leading to

penalties and disagreements with clients. NSCCL is extended the responsibility of

settling the delivery obligations of sellers and buyers dealt in a given settlement

period.

Board of Directors of Steel City Securities Limited

1. Mr. G. Sree Ram MurthyChairman Cum

Managing Director

2. Mr. G. Raja Gopal Reddy Executive Director

3. Mr. K. SatyanarayanaExecutive Director

(Surveillance)

4. Mr. Satish Kumar Arya Director (Operations)5. Mr. G. Satya Ram Prasad Director

THE VARIOUS SERVICE DEPARTMENTS IN SCSL ARE:

Systems Departments

Inspection Department

H.R. Department

Accounts

Deliveries

Depository Participant

Research and Development

ACTIVITIES OF STEELCITY:


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TRADING FACILITIES SETTLEMENT OF TRADES

FUNDS SECURITIES

PAY IN PAY OUTPAY IN PAY OUT

SECURITIESBOUGHTBY CLIENTS

LOSS

FUNDS

INTERNALFUNDS

NSE

PAY OUT OFCLIENTS

STEEL CITY SECURITIES LIMITED


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STRUCTURE OF THE COMPANY

The total control of the organisation is under the Chairman who is also the

Managing Director. Under him there are three Executive Directors for surveillance &

operations and also a Sleeping Director.

Mr.G.Sree Ram Murthy is the Chairman cum Managing Director, Mr.G.Raja

Gopal Reddy the Executive Director looks after the market development and opening

of new franchisees. He also looks after requirements of new and existing branches.

Mr.K.Satyanarayana the Executive Director, surveillance has an inspection team under

him for the purpose of vigilance in branches and franchises.

Mr.Satish Kumar Arya is the Director Operations. He controls the trading

limits, margins etc. All office related matters are dealt by him. He is also responsible

for meeting the requirements and following the rules set by the stock exchanges.

Mr.G.S.R.Prasad is the fourth Director who does not play any role in the day to day

working of the company.

General Manager (Operations) is Mr.Murali is responsible for De-Mat with

NSDL / CDSL. General Manager (Systems) is Mr.V.Srinivas who looks after the

Networking, Software, Hardware and trading related requirements and VSAT

connectivity. Finance and accounts were looked after by Mr.Ramu who is a Chartered

Accountant.

Mr. Samba Murthy is responsible for the trading and registration of new

clients. He is the Trading Manager. Mr. Krishna Naga Bhutan is the Marketing

Manager. He is also responsible for conduction various awareness seminars. The

legal section deals with the investors problems and legal issues with the company.

Even without relation to the company they render legal services.


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ORGANISATIONAL STRUCTURE

D i r e c t o r( O p e r a t io n s )

C h a ir m a n & M a n a g in g D i r e c t o r

P o r t f o l i oM a n a g e m e n t

S e r v ic e s

G e n e r a M a n a g e rO p e r a t io n s & S e c u r i t i e s

S r M a n a g e rS y s t e m s

A s s tM a n a g e r H R

G e n e r a lM a n a g e r I T

D e a le r s

S o f t w a r eP r o j e c t L e a d e r

S o f t w a r eD e v e l o p e r

D B A

H a r d w a r eE n g i n e e r

S y s t e m sA d m i n i s t r a t o r

H a r d w a r eT r a in e e

B r a n c hM a n a g e r

R e g io n a lM a n a g e r

B u s i n e s sD e v e l o p m e n t&

M a r k e t i n g

S r M a n a g e rL e g a l

B r a n c hM a n a g e r

E x e c u t i v eD i r e c t o r

R e g i o n a lM a n a g e r

T e c h n i c a lA n a l y s t

M a nL o g

S r M ( S u r v

M a n I n s p

B r a M a n

E x e c u t i v eD i r e c t o r

( S u r v e i l la n

R e g M a n

S r M a n a g e rA c c o u n t s

D y M a n a g e rA c c o u n t s

G e n e r a lM a n a g e r( F & A )

S t o r e s

A s s t M a n a g e r(L i a i s o n)M u m b a i

S r M a n a g e rS u r v i e ll a n c e

M a n a g e rT r a d i n g

S r M a n a g e rO p e r a t io n s

C o o r d i n a t o r

D PO p e r a t o r s

M a n a g e rC o m m o d it i e s

B r a n c h

M a n a g e r

R e g io n a lM a n a g e r

R & DE q u i t y

R & DD e r iv e t iv e s

R e s e a r c hE d i t o r

R e s e a r c hE d i t o r


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The different branches and franchisees of the company report directly to the

Head Office in Visakhapatnam and any activity taken up by these should be brought to

the notice of the Head Office. Every branch has a Branch Manager, Accountant,

Trading Manager and Trading Operator. The company has various functional

departments for its smooth functioning.

COMPANY POLICY:

The basic policy of SCSL, is not to indulge in own trading. The basic

principle of SCSL is total commitment in service to all clients. The service of SCSL is

prompt and hence there are not delays in payout of funds or deliveries to any client.

SCSL collects pay in T+1 and its payout in T+3 days. Through SCSL, trade in NSE

per day is 200 crores whereas, trade in BSE per day is 4 crores.

CAPITAL:

The base capital is set up a trade center is 1 crore, SCSL raised equity of

Rs.105 lakhs during its incorporation. Earlier, SCSL paid Rs.75 lakhs as base capital

to NSE when it was set up. Every trade corporation has to maintain a reserve of some

amount with NSE. At present, SCSL has 7.5 crores as margin with NSE.

WORKING STAFF:

There is 100 to 150 staff employed in SCSL. The staff draws a salary basing

on the cadre they are employed. The salaries in SCSL vary from Rs.2000 to Rs.20000

per month basing on the cadre of the employee.


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EMPLOYEE RECRUITMENT:

In SCSL, the top managements select the candidate and the letter of

appointment or rejection is sent to the Board of Directors. The Directors do the

placement in SCSL. The placement can either be in the Head Office or in any other

branches of SCSL.

PLANNING:

It involves planning of Human Resource Department i.e. recruitment, selection,

training etc. it also involves forecasting of personnel changing values, attitudes and

behavior of employees.

DIRECTING:

In this company, the personnel manager co-ordinates various managers at

different levels as the personnel functions are concerned. The wilting and effective

co-operation of employees for the attainment of organization goals is possible through

proper direction.

CONTROLLING:

In SCSL, the top management does the controlling. In this aspect, they do

auditing training programmes; directing moral surveys are some of the functions of the

top management.

RECRUITMENT:

It is the process of searching for prospective employees and simulating them to

apply for jobs in the organization. In SCSL, if they want any person, they will give

notification in newspaper in order to simulate eligible persons to apply for that job.


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EMPLOYEE RELATION:

The employee relations at all levels remains cordial. Training, Promotion and

Transfers are done in SCSL to motivate and increase the morale of the staff. All the

employees in SCSL from top to bottom perform their services with sincerity, hard

work, dedication and with team spirit due to which SCSL is considered as one of the

best stock trading firm in India.

SELECTION, PLACEMENT AND TRAINING:

The top management shall do the selections. Placement is in the head office

and in the branches of SCSL, which are in different places. Selected candidates are

placed in one of the branches of SCSL and gives proper training.

FUNCTIONS OF THE SCSL:

SCSL provides mock trading to its clients and members.SCSL provides complete automated system both in trading and settlement

process.

SCSL enables clients to trade both in NSE and BSE.

SCSL converts the paper shares into electronic shares through DMAT process.

SCSL provides market information.

SCSL acts as clearing member for trades taking place through its self.

SCSL is a depository participant of NSDL & CDSL and it is a trading and

clearing member of NSE & BSE.

FACILITIES PROVIDED TO CLIENT IN SCSL:

Gross exposure facility given in SCSL is 5 times. But, up to 10 times, it is

relaxed to clients. Turnover facility given in SCSL to clients is 33.33 times. But, therestrictions are not considered. Minimum of Rs.20,000 margin money is collected


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from professional clients who trade for speculation purpose. For deliver purpose, no

margin money is collected. Due to the total commitment in service to its clients,

SCSL is considered to be one of the best Stock Broking Companies in India.

NSE BRANCHES OF SCSL: NSE FRANCHISEES:

1. BACKOFFICE

To know the trade position of the client, back-office is done in SCSL everyday

immediately after the trade ends. STEEL PACK is the package used in back officesystem. Steel City Software team was designed and maintained this STEELPACK

Package.

The main modules of back office system are:

Trading

Finance

Importing ExportingMargins

Clearing

Business Controls

Payin-Payout

House Keeping

Rourkela Berhampur (2)Srikakulam VisakhapatnamChennai KukatpalliAnantapur BakaramChittor TenaliAmalapuram PidigurallaMadanapalli HanumakondaPanjagutta Erragadda

Mumbai GudiwadaSecunderabad KakinadaGajuwaka CuddapahVizianagaram Guntur Tirupathi Prodduttur Bhimavaram NarsaraopetVijayawada Chilakalurpet

Nellore Eluru Nandyala Ongole


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In the back office, first the Import Export module is opened where the

trade file of the days trade is collected and the text file was imported to the system.

There, the old closing prices are inserted by new prices from the Bhavcopy file.

Bhavcopy is the average of last half-an-hour prices of the scrips.

To calculate the net mark to market value, Bhavcopy file is imported from

NSE/BSE/NCDEX/MCX. Net mark to market value is to be known to know the profit

or loss position of the client, basing on which the Trading Manager of SCSL will

decide whether the client can trade or not for the next day on comparing it with the

margin paid by the client.

After importing the Bhavcopy file, the trading module is opened. In tradingmodule, the sauda status is known from the Sauda Manager. Sauda manager is the

number of trade confirmations recorded. Confirmation of trading transaction with

brokerage commission is known as Sauda.

After Sauda Manager, Net positions process is done. In the net positions

process, cumulative net position reports, client-wise net position reports and other

reports are made and are given to clients and to the accounts department. The bills are prepared and sent to the respective clients.

2. REPORTS:

After selecting REPORTS option from main menu, the member has to

specify the criteria for which the report is needed. The types of reports that may be

generated are: Net Position Reports Client Wise and Scrip Wise; Contract Note

reports; Client Wise Confirmation reports; Bills Summary reports; bad deliveries

reports; auctions reports; objections reports; margins reports; securities reports and

miscellaneous reports. The daily reports of various aspects relating to the trading

activities are maintained.

3. CLEARING:


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Settlement of trades transacted on an exchange requires smooth, preferably

instantaneous, movement of securities and funds in accordance with the prescribed

schedule of pay-in / pay-out. Movement of securities has been almost instantaneous in

the dematerialized environment. Two depositories are in place to provide electronic

transfer of securities. 10 major stock exchanges accounting for about 99% of turnover

have been connected to depositories. All actively traded scrips are held, traded and

settled in de-mat form. NSE follows a different model where a clearing corporation

guarantees settlement obligations emanating from trades.

4. SETTLEMENT:

The trades accumulated over a trading cycle are clubbed together at the end of

the trading cycle, positions (trades) are netted and the balance obligations are settled.

THE ONE TYPE OF SETTLEMENT

ROLLING SETTLEMENT:

In a rolling settlement, each trading day is considered as a trading period

and trades executed during the day are settled based on the net obligations for the day.

At NSE, trades in rolling settlement are settled on a T+2 basis i.e. on the 2nd

working day. For arriving at the settlement day all intervening holidays, which include

bank holidays, NSE holidays, Saturdays and Sundays are excluded. Typically trades

taking place on Monday are settled on Wednesday, Tuesday's trades settled on hursday

and so on.

The following table and figure represent rolling settlement process.

A tabular representation of the settlement cycle for rolling settlement is given below:

Table-4.1

Activity Day


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Trading Rolling Settlement Trading TClearing Custodial Confirmation T+1 working days

Delivery Generation T+1 working daysSettlement Securities and Funds pay in T+2 working days

Securities and Funds pay out T+2 working days

Valuation Debit T+2 working daysPost Settlement Auction T+3 working days

SETTLEMENT AGENCIES:

The NSCCL, with the help of clearing members, custodians, clearing

banks and depositories settles the trades executed on exchanges. The roles of each of

these entities are explained bellow:

a. NSCCL

b. CLEARING MEMBERS

c. CUSTODIANSd. CLEARING BANKS

e. DEPOSITORIES

f. PROFESSIONAL CLEARING MEMBER

EXPLANATIONS:

1. Trade details from Exchange to NSCCL (real-time and end of day trade file).

2. NSCCL notifies the consummated trade details to CMs/custodians who affirm

back. Based on the affirmation, NSCCL applies multilateral netting and

determines obligations.

3. Download of obligation and pay-in advice of funds/securities.

4. Instructions to clearing banks to make funds available by pay-in-time.

5. Instructions to depositories to make securities available by pay-in-time.


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6. Pay-in of securities (NSCCL advises depository to debit pool account of

custodians/CMs and credit its account and depository does it).

7. Pay-in of funds (NSCCL advises Clearing Banks to debit account of

custodians/CMs and credit its account and clearing bank does it).

8. Pay-out of securities (NSCCL advises Clearing Banks to credit account of

custodians/CMs and debit its account and depository does it).

9. Pay-out of funds (NSCCL advises Clearing Banks to credit account of

custodians/CMs and debit its account and clearing bank does it).

10. Depository informs custodians/CMs through DPs.

11. Clearing Banks inform custodians/CMs.

5. COST OF TRADING:

The various costs involved in the process of online trading in Steel City

Securities Limited, Visakhapatnam are as follows:

a. MARGINS:

The base capital to set up a trade center is one crore rupees. Earlier,

SCSL paid Rs.75 lakhs as base capital when it was set-up. The Trade Corporation has

to maintain a reserve of some amount with NSE where 30% - 50% will be in the form

of cash and the remaining in the form of bank guarantees (securities), FDRs etc.

SCSL has 7.5. crores as margin with NSE at present.

Gross intra-day turnover (buy and sell) of a member shall not exceed 25 times

the base capital. Gross exposure of a member at any time shall not exceed 8.5 times

the free base capital of one crore rupees and not exceed 12 times over the free base

capital of one crore rupees.

Minimum of Rs.20000 is collected as margin money from professional

clients in SCSL. For delivery purpose no margin money is collected. Client margin

collection is calculated in 16 types known as Span calculation and the maximum

margin is collected from the clients. SCSL collects 25% margin money in futures


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from clients. For trading in index 15% margin is charged. For retail clients, the full

amount of the value of shares is calculated and collected to allow them to purchase the

shares.

Table-5.1

Gross Exposure Margin Payable ( Rs. Crore)

1 3& 6& & 20 Rs. 220 lakh plus 20 % in excess of Rs.20

b. BROKERAGE:

Brokerage is of two types:

i. Speculation brokerage or square up commission:

This brokerage is charged where buying and selling of shares is done in

one day only and at the end of the days trade, the position is zero. The speculation

brokerage is charged from 0.01% to 0.03%.


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ii. Delivery Brokerage :

This brokerage is charged where there may be buying or selling lot

remaining at the end of the days trade. The delivery brokerage is charged from 0.03%

to 0.30%.

As per SEBI, maximum brokerage shouldnt exceed 2.5% both in BSE and

NSE. For retail clients, the brokerage charged is 0.7%. A sub-broker charge 2.5%

from the clients to sell or buy the shares out of which, SCSL charges 1% from the sub-

broker.

Service tax:

In SCSL, 10.3% service tax on brokerage is collected from the clients.

Stamp duty:

If the stamp duty of 0.006% on turnover is Rs30 or more, only Rs30 is

collected in NSE. In BSE, the minimum is 1Re and the maximum stamp duty is

unlimited.

Security Transaction Tax

This has reference to the Securities Transaction Tax (STT) introduced in the

Finance Act 2004. As per the Finance Act 2004, STT on the transactions executed on

the Exchange will be as under:

NSE, BSE:

Square up -------------0.25% on Turnover

Delivery --------------0.125% on Turnover

F&O

0.017% (Its calculate on Turnover only on Selling )

Options

0.017% (Based only on Premium)


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Exercise (only for options)

0.125% (Strike + Premium Multiplied by quantity)

6)ACCOUNTS:

The Accounts/ Finance department maintains the accounts in SCSL.

The accounts are prepared in three forms. They are:

a.Client-wise net positions,

b.Scrip-wise net positions,

c.Pay-in and Pay-out settlement of funds.

7)DEMATERIALIZATION AND ELECTRONIC TRANSFER OF SECURITIES:

Though de-mat was introduced in 1994, it came into existence in 1996.

The depositories Act, 1996 was passed to provide for the establishment of

depositories in securities with the objective of ensuring free transferability of

securities with speed, accuracy and security by dematerializing the securities in the

depository model. A depository holds securities in dematerialized form. It

maintains ownership records of securities and effects transfer of ownership through

book entry.

The two depositories, National Securities Depository Limited (NSDL) and

Central Depository Services Limited (CDSL) provide services to investors andclearing members through Depository Participants (DPs). They do not change the

investors and clearing members directly but charge their DPs, who are free to have

their own charge structure for their clients.

De-mat Process:

When a client places his physical shares for de-mat, SCSL after inputting the

information in depository participants sends the physical shares to the company, which


35/96

issued the shares. The client code number and the information and the clients

signature is sent to Share Holding Registrar.

When a client enters into DP for de-mat purpose, he is given a unique code

member. He can know his share position easily. It is known as client ID number.

6) INTERMEDIARIES :

There are no intermediaries in between SCSL and NSE, BSE, NCDEX

and MCX. Similarly there are no intermediaries in between SCSL and professional

clients. Since SCSL is a share broker to NSE, BSE ,NCDEX and MCX the clients

operating in SCSL directly, on behalf of other clients are sub-brokers to the ultimateclients who doesnt operate the trade directly. So, there may be subbrokers as

intermediaries in between SCSL and clients who do not trade directly in SCSL.

As mentioned earlier, SCSL is depository participant. So, SCSL acts as an

intermediary between clients and NSDL & CDSL.

7) MARKET INFORMATION:

In SCSL, daily the research analyst collects the market information and it is

analyzed. The market information is used to forecast the index movement, price

movement of the shares and enables the clients to make use of the information in

trading to get better results.

The research analyst in forecasting the market movement follows the technical

analysis, fundamental analysis and efficient market hypothesis. The research analyst


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collects the information about the company, the industry and the economy through

different media to know the companys position.

Since, the NSE & BSE are markets with strong form efficiency, as the market

discounts the information itself very quickly and changes as per the information, the

research analyst has only fewer jobs to do here.

The research analyst not only analyses the marketing information but, every

day in SCSL an edition of the research analysts, suggestions on scrips that have to be

bought and sold is also printed which helps the clients of SCSL to invest in shares that

are profitable.

Chapter 4

Overview


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Theoretical framework of derivative market

INTRODUCTION TO DERIVATIVES:

The emergence of the market for derivative products, most notably forwards,

futures and options, can be traced back to the willingness of risk-averse economic

agents to guard themselves against uncertainties arising out of fluctuations in asset

prices. As instruments of risk management, these generally do not influence the


38/96

fluctuations in the underlying asset prices. However, by locking-in asset prices on

the profitability and cash flow situation of risk-averse investors.

DEFINITION

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 is driven by the spot price of wheat which is the "underlying".

In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R)A)defines "Derivative" to include-

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.

A contract that derives its value from the prices, or index of prices, underlying

securities.

Index futures

One-month

Two-month

Three-month

Individual Stock Futures

One-month

Two-month

Three-month

Options Call Option

Index Options

One-month

Two-month


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Three-month

Individual Stock options

One-month

Two-month

Three-month

Put OptionIndex Options

One-month

Two-month

Three-month

Individual Stock options

One-month

Two-month

Three-month

PARTICIPANTS IN A DERIVATIVE MARKET

Derivatives attract three types of participants

Hedgers

Speculators

Arbitrageurs

GLOBAL DERIVATIVES MARKETS

Futures history can be traced back to middle ages where markets were meant to

address the needs of the farmers and the merchants. The Chicago Board Of

Trade(CBOT) was established in 1848 to bring farmers and merchants together.

Initially, its main task was to standardize the quantities and qualities of the grains that

were traded. The first futures type contract developed was called " to-arrive contract".

The CBOT now offers on many different underlying assets in commodities and

financial markets.

Many other exchanges in the world now offer futures contracts. Eurex, the German-

Swiss derivatives exchange, was the world's biggest financial futures exchange at the


40/96

end of 1999, overtaking the Chicago Board Of Trade for the first time after a huge

increase in contracts traded in 1999. Eurex traded more than 379 million contracts

during 1999, 53% more than in 1998. This is expected to be well above the

comparable figure for the CBOT, where officials are expecting a fall of about 10%

from the 1998 total, when record 281.2 million contracts were traded.

LIFFE, the London market, is also expecting a sharp fall in volumes to some 120

million contracts, compared with 194 million in 1998. MATIF, the French derivatives

market traded 183 million contracts in 1999, more than double its 1998 total. LIFFE

lost its European lead when trading in the futures contracts on 10-year German

government bonds (bunds) migrated to the electronic Eurex system two years ago.

Like the CBOT, trading volumes are also likely to be lower at the Chicago Mercantile

Exchange, the second biggest US futures market.Major Equity Derivative Exchanges

in the World

1. Chicago Mercantile Exchange (CME) 4

2. Eurex

3. Hong Kong Futures Exchange

4. The London Int. Financial Futures and Options Exchange (LIFFE)5. Singapore Exchange

6. Sydney Futures Exchange

DERIVATIVES MARKET IN INDIA

Derivatives markets broadly can be classified into two categories, those that are traded

on the exchange and those traded one to one or 'over the counter 7. They are hence

known asExchange Traded Derivatives

OTC Derivatives (over the counter)

OTC Equity Derivatives

Traditionally equity derivatives have a long history in India in the OTC

market.

Options of various kinds (called Teji and Mandi and Fatak) in

unorganized markets were traded as early as 1900 in Mumbai.


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The SCRA however banned all kind of options in 1956.

The following factors have been driving the growth of financial derivative:

1. Increased volatility in asset prices in financial markets.

2. Increased integration of national financial markets with the international

markets.

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.

TYPES OF DERIVATIVES:

Forwards:

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,

the parties to the contract negotiate price and quantity bilaterally. The forward

contracts are normally traded outside the exchanges. This process of standardization

reaches its limit in the organized futures market. Forward contracts are very useful in

hedging and speculation.

STRATEGIES TO USE DERIVATIVES TRADING

1. HEDGINGThe classic hedging application would be that of an exporter who expects to receive

payment in dollars 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 uncertainty. Similarly an importer who is required to

make a payment in dollars two months hence can reduce his exposure to exchange rate

fluctuations by buying dollars forward.

2. SPECULATOR


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If a speculator has information or analysis, which forecasts an upturn in a

price, then he can go long on the forward market instead of the cash market. The

speculator would go long on the forward, wait for the price to rise, and then take a

reversing transaction to book profits. Speculators may well be required to deposit a

margin upfront. However, this is generally a relatively small proportion of the

value of the assets underlying the forward contract. The use of forward markets here

supplies leverage to the speculator.

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.

On the expiration date, the contract has to be settled by delivery of theasset.

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.

FUTURES:

History:

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

price. But unlike forward contracts, the futures contracts are standardized and

exchange traded.

The first exchange that traded financial derivatives was launched in Chicago in the

year 1972. A division of the Chicago Mercantile Exchange, it was called the

International Monetary Market (IMM) and traded currency futures. The brain behind

this was a man called Leo Me lamed, acknowledged as the "father of financial futures"

who was then the Chairman of the Chicago Mercantile Exchange. Before IMM opened

in 1972, the Chicago Mercantile Exchange sold contracts whose value was counted in

millions. By 1990, the underlying value of all contracts traded at the Chicago

Mercantile Exchange totaled 50 trillion dollars.

These currency futures paved the way the way for the successful marketing of a

dizzying array of similar products at the Chicago Mercantile Exchange, the Chicago

Board of Trade, and the Chicago Board options Exchange. By the 1990's these

exchanges were trading futures and options on everything from Asian and American


43/96

stock indexes to interest rate swaps, and their success transformed Chicago almost

overnight into the risk-transfer capital of the world.

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-to-market.

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.

Difference between Futures & Forwards

FUTURES FORWARDS

1 Traded on an Organized exchange 1 Over the Counter in nature

2 Requires Margin payments 2 No margin payments required

3 Daily settlement 3 Settlement takes place at the end of the

period

4 Standardized Contract terms 4 Customized Contract terms

5 Higher Liquidity 5 Lesser liquidity

Options:


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History:

Options made their first major mark in financial history during the tulip-bulb mania in

seventeenth century Holland. It was one of the most spectacular get rich quick binges

in history. The first tulip was brought into Holland by a botany professor from Vienna.

Over a decade, the tulip became the most popular and expensive item in Dutch

gardens. The more popular they became, the more tulip bulb prices began rising. That

was when options came into the picture. They were initially used for hedging. By

purchasing a call option on tulip bulbs, a dealer who was committed to a sales contract

could be assured of obtaining a fixed number of bulbs for a set price. Similarly, tulip-

bulb growers could assure themselves of selling their bulbs at a set price by purchasing

put options.

Although options have existed for a long time, they were traded OTC, without much

knowledge of valuation. The first trading in options began in Europe and the US as

early as the seventeenth century. It was only in the early 1900s that a group of firms

set up what was known as the put and call Brokers and Dealers Association with the

aim of providing a mechanism for bringing buyers and sellers together. If someone

wanted to buy an option, he or she would contact one of the member firms. The firm

would then attempt to find a seller or writer of the option either from its own clients or

those of other member firms. If no seller could be found, the firm would undertake to

write the option itself in return for a price. This market however suffered from two

deficiencies.

First, there was no secondary market and

Second, there was no mechanism to guarantee that the writer of the option

would honor the contract.

In 1973, Black, Merton and Scholes invented the famed Black-Scholesformula. In April 1973, CBOE was set up specifically for the purpose of trading

options. The market for options developed so rapidly that by early '80s, the number of

shares underlying the option contract sold each day exceeded the daily volume of

shares traded on the NYSE. Since then, there has been no looking back.

CRITERIA FOR STOCKS ELIGIBLE FOR OPTIONS TRADING:


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The following criteria will have to be met before a stock can be considered eligible for

options trading.

The stock should be amongst the top 200 scrips, on the basis of average

market capitalization during the last six months and the average free float market

capitalization should not be less than Rs. 750 Crore. The free float market

capitalization means the non-promoter holding in the stock. The non-promoter holding

in the company should be at least 30%.

The stock should be amongst the top 200 scrips on the basis of average daily

volume (in value terms), during the last six months. Further, the average daily volume

should not be less than Rs. 5 Crore in the underlying cash market.

The stock should be traded on atleast 90% of the trading days in the last six

months.

The ratio of the daily volatility of the stock vis-a-vis the daily volatility of the

index should not be more than4, at any time during the previous six months.

Based on these criteria, SEBI approved trading in option contracts on 31

stocks.

Index options: These options have the index as the underlying. Some options are

European while others are American. Like indexing futures contracts, indexing options

contracts are also cash settled.

Stock options: Stock options are options on individual stocks. Options currently trade

on over 500 stocks in the United States. A contract gives the holder the right to buy or

sell shares at the specified price.

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: 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.


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American options: American options are options that can be exercised at any time

upto the expiration date. Most exchange-traded options are American.

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 cashflow if it was 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 cashflow it was exercised immediately. A call option on the

index is out-of-the-money when the current index stands at a level that 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 -S t). 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.


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Differences between Futures and Options

Table1Futures Options

1 Price is zero, Strike price moves 1 Strike price is fixed, price moves

2 Price is zero 2 Price is always positive

3 Linear pay-off 3 Non-Linear pay-off

4 Both long & short at risk 4 Only short at risk.

Similarities between Futures & OptionsTable2

Futures & options

1 Exchange traded

2 Exchange defines the product

TYPES OF OPTIONS

There are two basic types of options, call options and put options.

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.

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.

There are a minimum of 5 strike prices, two 'in-the-money', one 'at-the-money' and

two 'out-of-the-money' for every call and put option. At any point of time there are

only three contracts available for trading, with 1 month, 2 months and 3 months to

expiry. These contracts expire on last Thursday of the expiry month and have a

minimum of 3 month expiration cycle.

RISK MANAGEMENT

Four steps in risk management:


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Understand the nature of various risks.

Define a risk management policy for the organization and quantifying

Maximum risk that organization is willing to take if quantifiable.

Measure the risks if quantifiable and enumerate otherwise.

Build internal control mechanism to control and monitor all risks.

Step 1 - Understand Risks

Risks can be classified into three categories.

Price or Market Risk

Counterparty or Credit Risk

Operating Risks

Price Risks

This is the risk of loss due to change in market prices. Price risk can increase further

due to Market Liquidity Risk, which arises when large positions in individual

instruments or exposures reach more than a certain percentage of the market,

instrument or issue. Such a large position could be potentially illiquid and be capable

of being replaced or hedged out at the current market value and as a result may be

assumed to carry extra risk.Counter party Risks

This is the risk of loss due to a default of the Counter party in honoring its

commitment in a transaction (Credit Risk). If the Counter party is situated in another

country, this also involves Country Risk, which is the risk of the Counter party not

honoring its commitment because of the restrictions imposed by the government

though counter party itself is capable to do so.

Dealing Risk

Dealing Risk is the sum total of all unsettled transactions due for all dates in future. If

the Counter party goes bankrupt on any day, all unsettled transactions 1ould have to

be redone in the market at the current rates. The loss would be the differenced between

the original contract rate and the current rates. Dealing risk is therefore limited to only

the movement in the prices and is measured as a percentage of the total exposure.

Settlement Risk


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Settlement risk is the risk of Counterparty defaulting on the day of the settlement. The

risk in this case would be 100% of the exposure if the corporate gives value before

receiving value from the Counterparty. In addition the transaction would have to be

redone at the current market rates.

Operating Risks

Operational risk is the risk that the organization may be exposed to financial loss

either through human error, misjudgment, negligence and malfeasance, or through

uncertainty, misunderstanding and confusion as to responsibility and authority.

Following are the different kinds of operating risks:

Legal

Regulatory

Errors & Omissions

Frauds

Custodial

Systems

LegalLegal risk is the risk that the organization will suffer financial loss either because

contracts or individual provisions thereof are unenforceable or inadequately

documented, or because the precise relationship with the counterparty is unclear.

Regulatory

Regulatory risk is the risk of doing a transaction, which is not as per the prevailing

rules and laws of the country.

Errors & Omissions

Errors & Omissions are not uncommon in financial operations. These may relate to

price, amount, value date, currency, and buy/sell side or settlement instructions.

Frauds

Some examples of frauds are:

Front running


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Circular trading

Undisclosed Personal trading

Insider trader

Routing deals to select brokers

Custodial

Custodial risk is the loss of prime documents due to theft, fire, water,

termites etc. This risk is enhanced when the documents are in transit.

Systems

Systems risk is due to significant deficiencies in the design or operation of supporting systems; or inability of systems to develop quickly enough to meet rapidly

evolving user requirements; or establishment of a great many diverse, incompatible

system configurations, which cannot be effectively linked by the automated

transmission of data and which require considerable manual intervention.

Step 1 - Define Risk Policy

Decide the basic risk policy that the organization wants to have. This may

vary from taking no risk (cover all) to taking high risks (open all). Most organizationswould fall somewhere in between the two extremes. Risk and reward go hand in hand.

Cost Center vs. Profit Center

A cost center approach looks at exposure management as insurance against adverse

movements. One is not looking for optimization of cost or realization but meeting

certain budgeted or targeted rates. In a profit center approach, the business is taking

deliberate risks to make money out of price movements.

Step 2- Risk Measurement

There are a number of different measures of price or market risk, which is mainly,

based on historical and current market values Examples and Value At Risk (VAR),

Revaluation, modeling, Simulation, Stress Testing, Back Testing, etc.

Step 3- Risk Control


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Control of Price Risk

Position limits are established to control the level of price or market risk taken by the

organization. Diversification is used to reduce systematic risk in a given portfolio.

Control of Credit Risk

Credit limits are established for each counter party, for both Dealing Risk and

Settlement Risk separately depending upon the risk perception of the counter party.

Control of Operating Risk Establishment of an effective and efficient internal control structure over the trading

and settlement activities, as well as implementing a timely over and accurate

management information system (MLS)

A. FUTURES:

A future contract is an agreement between two parties to buy or sell an asset at certain

time. In the future at a certain price. Future contrasts are special types of forward

contrasts, in the sense that the former are standardized exchange-trade contrasts.

a. INDEX FEATURES. b. INDIVIDUAL STOCK FEATURES.

a. INDEX FUTURES:

NSE trades nifty futures contract having expiry cycle for index futures. All the

contrasts expiry date is last Thursday of every month.

1. One - Month

2. Two - Month

3. Three - Month

b. INDIVIDUAL STOCK FUTURES:

Trading in individual stock futures commenced on the NSE November 2001. These

contrasts are cash settled on T+l basis.

Expiry cycle for stock futures

1. One - month

2. Two -month

3. Three month


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A new contract is introduced on the trading day following the expiry of the

near month contract.

B. OPTIONS:

Options are fundamentally different from towards and futures contracts. An options

dues the holder of the option the right to do some thing. The holder dose not have to

exercise this right. In contrast, in a forward or futures contract, the two parties have

committed them selves to doing some thing.

OPTIONS ARE TWO TYPES

a. Call option

b. Put option

A. CALL OPTION: A call option means gives the holder the right but not the

obligation to sell an asset by a certain date for certain price.

1. INDEX OPTION

2. INDIVIDUAL STOCK OPTION

1. INDEX OPTION: these options have index as the underlying. Some options are

European while others are American.

Expiry cycle for index option:

1. One - Month

2. Two - Month

3. Three -Month

2. INDIVIDUAL STOCK OPTION:

Stock options are options on individual stocks. Options currently trade on

over 500 stocks in the United States. A contact gives the holder the right to buy or sell

a share at the specified price.

Expiry cycle for stock options:

1.One -Month

2.Two -Month

3.Three Month

B. PUT OPTIONS:


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A put option gives the holder the right but not the obligation to sell and asse5t y a

certain date for a certain price.

The put option is two types:

a. INDEX OPTION

b. INDIVIDUAL STOCK OPTION

A. INDEX OPTION:

On NSE index option market, contracts at different strikes.

Expiry cycle for index option:

1. One -Month

2. Two -Month3. Three -Month

B .INDIVIDUAL STOCK OPTION:

Trading in stock option commence on the NSE from July 2001 these contracts are

American style and or settled in cash.

Expiry cycle for stock option:

1. One - Month

2. Two -Month

3. Three -Month

FUTURES AND OPTIONS MARKET TRADING SYSTEM

The software for Futures and Options Market has been developed to facilitate

efficient and transparent trading in futures and options instruments. Keeping in view

the familiarity of trading members with the current Capital market trading system,

modifications have been performed in the existing capital market trading system so as

to make it suitable for trading futures and options.

Basic Trading Terminology


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BASIS OF TRADING

The NEAT-F&O system supports an order driven market, wherein orders

match automatically. Order matching is essentially on the basis of security, its price,

time and quantity. All quantity fields are in units and price in rupees. The Exchange will

notify the regular lot size and ticks size for each of the contracts traded on this segment

from time to time.

When any order enters the trading system, it is an active order. It tries to find a match on

the other side of the book. If it finds a match, a trade is generated. If it does not find a

match, the order becomes passive and goes and sits in the respective outstanding order

book in the system.

Member type

1. TM

2. CM+TM

3. PCM + TM

4. PCM

Case (I): Clearing Member Corporate Manager:

(i) Can view outstanding orders, previous trades and Net position of his client Trading

Members by putting the TM ID and leaving the Branch Id and dealer id blank.

Case (II): Clearing Member and Trading Member Corporate Manager:

(i) Can view outstanding orders, previous trades and Net position of his client Trading

Members by putting the TM ID and leaving the Branch Id and dealer id

blank.

(ii) Can view outstanding orders, previous trades and Net positions entered for himself

by entering his own TMID, Branch Id and User Id. This is his default

Case (III): Clearing Member and Trading Member Dealer:

(1) Can only view requests entered by him.

Case (IV): Trading Member Corporate Manager:

1. Can view outstanding requests and activity log for requests entered by him by

entering his own Branch and User Ids. This is his default screen.

2. Can view outstanding requests entered by his dealers and/or branch managers

by either entering the Branch and/or User Ids or leaving them blank.


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MARKET TYPE

The Futures and Options Market system has one type of market i.e. the Normal

Market

Normal Market

Normal market consists of various book types wherein orders are segregated as

Regular lot orders and Stop Loss orders depending on their order attributes. All orders

have to be of regular lot size or multiples thereof.

ORDER BOOKS

As and when valid orders are entered or received by the system, they are first

numbered, time stamped and then scanned for a potential match. This means that each

order has a distinctive order number and a unique time stamp on it. If a match is not

found, then the orders are stored in the books as per price/time priority.

Price priority means that if two orders are entered into the system, the order having the

best price gets priority. Time priority means if two orders having the same price are

entered; the order entered first gets priority.

Best price for a sell order is the lowest price and for a buy order, it is the highest price.

The Futures and Options Market segment has following types of books:

Regular Lot Book

The Regular Lot Book contains all regular lot orders. The system first attempts to

match an active regular lot order against passive orders in this book.

Stop-Loss Book

Stop Loss orders are stored in this book till the trigger price specified in the order is

reached or surpassed. When the trigger price is reached or surpassed, the order is

queued for entry into the Regular lot book.

The stop loss condition is met under the following circumstances:

Sell Order - A sell order in the Stop Loss book gets triggered when the last traded

price in the normal market reaches or falls below the trigger price of the order.

Buy Order - A buy order in the Stop Loss book gets triggered when the last traded

price in the normal market reaches or exceeds the trigger price of the order.


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ORDER TYPES AND CONDITIONS

The system allows the trading members to enter orders with various conditions

attached to them as per their requirements. These conditions are broadly divided into

the following categories:

Time Conditions

Price Conditions

Other Conditions

Several combinations of the above are allowed thereby providing enormous flexibility

to the users. The order types and conditions are summarized below.

Time Conditions

DAY ORDER - A DAY order, as the name suggests is an order which is valid

for the day on which it is entered. If the order is not executed during the day, the

system cancels the order automatically at the end of the day.

IOC - An Immediate or Cancel (IOC) order allows the user to buy or sell a

contract as soon as the order is released into the system, failing which the order

is cancelled from the system. Partial match is possible for the order, and the

unmatched portion of the order is cancelled immediately.

Price Condition

STOP-LOSS - This facility allows the user to release an order into the system, after

the market price of the security reaches or crosses a there sold price

THE TRADING DAY

The system is normally made available for trading on all days except Saturdays,

Sundays and other Exchange notified holidays.

A trading day typically consists of a number of discrete stages as explained below:

PRE-OPEN PHASE

The Pre-Open period is applicable only to regular lot orders in the normal market. At

the start of Pre-Open session, market watch and messages are downloaded at the trader

workstations. For the trading member, all functions are available except quick order


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cancellation. Order matching takes place based on which a potential opening price is

computed and displayed although no trades are generated.

The Trading Member can carry out the following activities at this stage:

Set up Market Watch (contracts which the user would like to view on screen)

Inquiries

Order Entry

Order Cancellation (Quick Order Cancellation is not allowed)

Order Modification

At the start of the Pre-Open phase, a message is displayed indicating that the market is

in Pre-Open phase.

OPENING

This is a transition phase between pre-open and open phases. This phase immediately

follows the end of market pre-open phase. A user who does not login before the end of

pre-open period will not be able to do so until normal market opens for trading. Users

can enter orders during the opening phase. However, the system confirms these orders

only after the normal market opens for trading.

During this phase the system generates actual trades across all contracts fromvarious buy / sell orders present in the system. All the trades in a given contract will be

executed at the opening price of that contract. The opening price will be the LTP value

calculated when the pre-open phase ends. The start and end of the opening phase is

indicated by the following system messages:

Start Message: The Pre-open period has ended. Please wait for contracts to

be opened for trading.

End Message: The Normal market has opened.OPEN PHASE

The open period indicates the commencement of trading activity. To signify the start

of trading, a message is sent to all trader workstations. Order entry is allowed when all

contracts have been opened. During this phase, orders are matched on a continuous

basis. Trading in all instruments is allowed unless Exchange specifically prohibits

them.

The following activities are allowed at this stage: Inquiries


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Order Entry

future and options

Documents