Source: NSE

What are derivatives?

Derivatives, such as options or futures, are

financial contracts which derive their value off a
spot price time-series, which is called “the
underlying". For examples, wheat farmers may
wish to contract to sell their harvest at a future
date to eliminate the risk of a change in prices by
that date. Such a transaction would take place
through a forward or futures market. This market
is the “derivative market", and the prices on this
market would be driven by the spot market price
of wheat which is the “underlying". The terms
“contracts" or “products" are often applied to
denote the specific traded instrument.The world
over, derivatives are a key part of the financial
system. The most important contract types are
futures and options, and the most important
underlying markets are equity, treasury bills,
commodities, foreign exchange and real estate.
 
 
What is a forward contract?
 
In a forward contract, two parties agree to do a
trade at some future date, at a stated price and
quantity. No money changes hands at the time
the deal is signed.
 
 
Why is forward contracting useful?

Forward contracting is very valuable in hedging

and speculation.The classic hedging application
would be that of a wheat farmer forward-selling
his harvest at a known price in order to eliminate
price risk. Conversely, a bread factory may want
to buy bread forward in order to assist production
planning without the risk of price fluctuations.
 
If a speculator has information or analysis which
forecasts an upturn in a price, then she 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. The use of forward
markets here supplies leverage to the speculator.
 
 
What are the problems of forward markets?

Forward markets worldwide are afflicted by

several problems: 
 
  (a) lack of centralisation of trading,
  (b) illiquidity, and 
  (c) counterparty risk.
 
In the first two of these, the basic problem is that
of too much flexibility and generality. The forward
market is like the real estate market in that any
two consenting adults can form contracts against
each other. This often makes them design terms
of the deal which are very convenient in that
specific situation for the specific parties, but
makes the contracts non-tradeable if non-
participants are involved. Also the “phone
market" here is unlike the centralisation of price
discovery that is obtained on an exchange.
Counterparty risk in forward markets is a simple
idea: when one of the two sides of the
transaction chooses to declare bankruptcy, the
other suffers. Forward markets have one basic
property: the larger the time period over which
the forward contract is open, the larger are the
potential price movements, and hence the larger
is the counter- party risk.
 
Even when forward markets trade standardized
contracts, and hence avoid the problem of
illiquidity, the counterparty risk remains a very
real problem. 
 
 
What is a futures contract?

Futures markets were designed to solve all the

three problems listed above of forward markets.
Futures markets are exactly like forward markets
in terms of basic economics. However, contracts
are standardised and trading is centralised, so
that futures markets are highly liquid. There is no
counterparty risk (thanks to the institution of a
clearinghouse which becomes counterparty to
both sides of each transaction and guarantees the
trade). In futures markets, unlike in forward
markets, increasing the time to expiration does
not increase the counter party risk.
 
 
What is the difference between Forward and
futures contract?

Forward Futures
 
Contract Contract
Nature of Non- Standardized
Contract standardized / contract
Customized
contract
Trading Informal Over- Traded on an
 the-Counter exchange
market; Private
contract
between parties
Settlemen Single - Pre- Daily settlement,
t specified in the known as Daily
contract mark to market
settlement and
Final Settlement.
Risk Counter-Party Exchange
risk is present provides the
since no guarantee of
guarantee settlement and
isprovided hence no
counter party
risk.
 
 
What are various types of derivatives traded
at NSE ?
 
There are two types of derivatives products
traded on NSE namely Futures and Options 

Futures: 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. All
the futures contracts are settled in cash.

Options: An Option is a contract which gives the

right, but not an obligation, to buy or sell the
underlying at a stated date and at a stated price.
While a buyer of an option pays the premium and
buys the right to exercise his option, the writer of
an option is the one who receives the option
premium and therefore obliged to sell/buy the
asset if the buyer exercises it on him.
 
Options are of two types - Calls and Puts
options :
 
"Calls" give the buyer the right but not the
obligation to buy a given quantity of the
underlying asset, at a given price on or before a
given future date. 
 
"Puts" give the buyer the right, but not the
obligation to sell a given quantity of underlying
asset at a given price on or before a given future
date. All the options contracts are settled in cash.
Further, the Options are classified based on
type of exercise. At present the Exercise
style can be European or American.
 
American Option - American options are options
contracts that can be exercised at any time upto
the expiration date. Options on individual
securities available at NSE are American type of
options.
 
European Options - European options are
options that can be exercised only on the
expiration date. All index options traded at NSE
are European Options.
 
 
What are “exotic" derivatives?
 
Options and futures are the mainstream
workhorses of derivatives markets worldwide.
However, more complex contracts, often called
exotics, are used in more custom situations. For
example, a computer hardware company may
want a contract that pays them when the rupee
has depreciated or when computer memory chip
prices have risen. Such contracts are “custom-
built" for a client by a large financial house in
what is known as the “over the counter"
derivatives market. These contracts are not
exchange-traded. This area is also called the
“OTC Derivatives Industry".
 
An essential feature of derivatives exchanges is
contract standardisation. All kinds of wheat are
not tradeable through a futures market, only
certain defined grades are. This is a constraint for
a farmer who grows a somewhat different grade
of wheat. The OTC derivatives industry is an
intermediary which sells the farmer insurance
which is customised to his needs; the
intermediary would in turn use exchange-traded
derivatives to strip off as much of his risk as
possible.
 
 
Why are derivatives useful?
 
The key motivation for such instruments is that
they are useful in reallocating risk either across
time or among individuals with different risk-
bearing preferences.
 
One kind of passing-on of risk is mutual insurance
between two parties who face the opposite kind
of risk. For example, in the context of currency
fluctuations, exporters face losses if the rupee
appreciates and importers face losses if the rupee
depreciates. By forward contracting in the dollar-
rupee forward market, they supply insurance to
each other and reduce risk. This sort of thing also
takes place in speculative position taking, the
person who thinks the price will go up is long a
futures and the person who thinks the price will
go down is short the futures.
 
Another style of functioning works by a risk-
averse person buying insurance, and a risk-
tolerant person selling insurance. An example of
this may be found on the options market : an
investor who tries to protect himself against a
drop in the index buys put options on the index,
and a risk-taker sells him these options.
Obviously, people would be very suspicious about
entering into such trades without the institution
of the clearinghouse which is a legal counterparty
to both sides of the trade.
 
In these ways, derivatives supply a method for
people to do hedging and reduce their risks. As
compared with an economy lacking these
facilities, it is a considerable gain.
 
The ultimate importance of a derivatives market
hence hinges upon the extent to which it helps
investors to reduce the risks that they face. Some
of the largest derivatives markets in the world are
on treasury bills (to help control interest rate
risk), the market index (to help control risk that
is associated with fluctuations in the stock
market) and on exchange rates (to cope with
currency risk).
 
 
What are various instruments available for
trading in Futures and Options?
 Index Futures
 
 Index Options
 
 Stock Futures
 
 Stock Options
 
 Currency Futures and 
 
 Interest Rate Futures

 
When were Index Futures and Index options
made available for trading at NSE?
 
Index Futures were made available for trading at
NSE on June 12, 2000 and Index Options were
made available for trading at NSE on June 4,
2001. S&P CNX Nifty Futures was the first index
on which index futures and options was
introduced. 
 
 
When were Stock Futures and stock options
made available for trading at NSE?
 
Stock Futures were made available for trading at
NSE on July 2, 2001 and stock options were
made available for trading at NSE on November
9, 2001. 
 
 
When was currency futures made available
for trading at NSE ?
 
Currency futures on the USD-INR pair exchange
rate was made available for trading on August 29,
2008.
 
 
When was interest rate futures made
available for trading at NSE?
 
Interest Rate futures were made available for
trading on August 31, 2009.
 
 
Are there different trading segments at NSE
which offer futures and options instruments
with different types of underlying?
 
Yes, two different trading segments at NSE offer
different kind of instruments in futures and
options. The futures and options with the
underlying as index and stock are traded on the
Futures and Options segment while the futures
and options with the underlying as exchange rate
of currencies or the coupon of a notional bond (in
case of interest rate derivatives) are traded on
the Currency derivatives segment.
 
 
Why Should I trade in derivatives?

Futures trading will be of interest to those who

wish to:
1) Invest - take a view on the market and buy
or sell accordingly.
 
2) Price Risk Transfer- Hedging - Hedging is
buying and selling futures contracts to offset
the risks of changing underlying market
prices. Thus it helps in reducing the risk
 associated with exposures in underlying
market by taking a counter- positions in the
futures market. For example, the hedgers
who either have security or plan to have a
security is concerned about the movement in
the price of the underlying before they buy or
sell the security. Typically he would take a
short position in the Futures markets, as the
cash and futures price tend to move in the
same direction as they both react to the same
supply/demand factors.
 
3) Arbitrage - Since the cash and futures price
tend to move in the same direction as they
both react to the same supply/demand
factors, the difference between the
underlying price and futures price called as
basis. Basis is more stable and predictable
than the movement of the prices of the
underlying or the Futures price. Thus
arbitrageur would
 
4) Predict the basis and accordingly take
positions in the cash and future markets.
 
5) Leverage- Since the investor is required to
pay a small fraction of the value of the total
contract as margins, trading in Futures is a
leveraged activity since the investor is able to
 control the total value of the contract with a
relatively small amount of margin. Thus the
Leverage enables the traders to make a
larger profit or loss with a comparatively
small amount of capital.
 
Options trading will be of interest to those
who wish to:
1) Participate in the market without trading or
holding a large quantity of stock
2) Protect their portfolio by paying small
premium amount
 
 
Benefits of trading in Futures and Options
1) Able to transfer the risk to the person who is
willing to accept them
2) Incentive to make profits with minimal
amount of risk capital
3) Lower transaction costs
4) Provides liquidity, enables price discovery in
underlying market
5) Derivatives market are lead economic
indicators.
6) Arbitrage between underlying and derivative
market.
7) Eliminate security specific risk.
 
 
What are the benefits of trading in Index
Futures compared to any other security?
 
An investor can trade the 'entire stock market' by
buying index futures instead of buying individual
securities with the efficiency of a mutual fund.
The advantages of trading in Index Futures are:
 The contracts are highly liquid
 Index Futures provide higher leverage
than any other stocks
 It has lower risk than buying and holding
stocks
 It is just as easy to trade the short side as
the long side
 Only have to study one index instead of
100's of stocks
 
Who uses index derivatives to reduce risk?
 
There are two important types of people who may
not want to bear the risk of index fluctuations: 
 
   A person who thinks Index fluctuations
are peripheral to his activity 
For example, a person who works in
primary market underwriting, effectively has
index exposure - if the index does badly,
then the IPO could fail. But this exposure
 has nothing to do with his core competence
and interests (which are in the IPO market).
Such a person would routinely measure his
index exposure on a day-to-day basis and
use index derivatives to strip off that risk.
Similarly, a person who takes positions in
individual stocks implicitly suffers index
exposure. A person who is long ITC is
effectively long ITC and long Index. If the
index does badly, then his “long ITC"
position suffers. A person like this, who is
focussed on ITC and is not interested in
taking a view on the Index would routinely
measure the index exposure that is hidden
inside his ITC exposure, and use index
derivatives to eliminate this risk
 A person who thinks Index fluctuations
are painful
An investor who buys stocks may like the
peace of mind of capping his downside loss.
Put options on the index are the ideal form
of insurance here. Regardless of the
composition of a person's portfolio, index
put options will protect him from exposure
to a fall in the index. To make this concrete,
consider a person who has a portfolio worth
Rs.1 million, and suppose Nifty is at 1000.
Suppose the person decides that he wants
to never suffer a loss of worse than 10%.
Then he can buy himself Nifty puts worth
Rs.1 million with the strike price set to 900.
If Nifty drops below 900 then his put
options reimburse him for his full loss. In
this fashion, “portfolio insurance" through
index options will greatly reduce the fear of
equity investment in the country. 
 
More generally, anytime an investor or a
fund manager becomes uncomfortable, and
does not want to bear index fluctuations in
the coming weeks, he can use index futures
or index options to reduce (or even
eliminate) his index exposure. This is far
more convenient than distress selling of the
underlying equity in the portfolio.
Conversely, anytime investors or fund
managers become optimistic about the
index, or feel more comfortable and are
willing to bear index fluctuations, they can
increase their equity exposure using index
derivatives. This is simpler and cheaper
than buying underlying equity. In these
ways, the underlying equity portfolio can be
something that is “slowly traded", and index
derivatives are used to implement day-to-
day changes in equity exposure.
 
How will retail investors benefit from index
derivatives?
 
The answer to this fits under “People who find
Index fluctuations painful". Every retail investor
in the economy who is in pain owing to a
downturn in the market index is potentially a
happy user of index derivatives.
 
 
If a contract is just a relationship between
long and short, how do we ensure “contract
performance"?
 
The key innovation of derivatives markets is the
notion of the clearinghouse that guarantees the
trade. Here, when A buys from B, (at a legal
level) the clearinghouse buys from B and sells to
A. This way, if either A or B fail on their
obligations, the clearinghouse fills in the gap and
ensures that payments go through without a
hitch. The clearinghouse, in turn, cannot create
such a guarantee out of thin air. It uses a system
of initial margin and daily mark-to-market
margins, coupled with sophisticated risk
containment, to ensure that it is not bankrupted
in the process of supplying this guarantee.
 
 
What is the role of arbitrage in the
derivatives area?
 
All pricing of derivatives is done by arbitrage, and
by arbitrage alone.
 
In other words, basic economics dictates a
relationship between the price of the spot and the
price of a futures. If this relationship is violated,
then an arbitrage opportunity is available, and
when people exploit this opportunity, the price
reverts back to its economic value.
 
In this sense, arbitrage is basic to pricing of
derivatives. Without arbitrage, there would be no
market efficiency in the derivatives market:
prices would stray away from fair value all the
time. Indeed, a basic fact about derivatives is
that the market efficiency of the derivatives
market is inversely proportional to the
transactions costs faced by arbitrageurs in that
market. When arbitrage is fluent and effective,
market efficiency is obtained, which improves the
attractiveness of the derivatives from the
viewpoint of users such as hedgers or
speculators. 
 
 
What happens if there are only a few
arbitrageurs ready to function in the early
days of the market?
 
In most countries, there are bigger arbitrage
opportunities in the early days of the futures
market. As larger resources and greater skills get
brought into the arbitrage business, these
opportunities tend to vanish.
 
India is better placed in terms of skills in
arbitrage, as compared with many other
countries, thanks to years of experience with “line
operators" who are used to doing arbitrage
between exchanges. These kinds of traders would
be easily able to redirect their skills into this new
market. These “line operators" are fluent with a
host of real-world difficulties, such as different
expiration dates on different exchanges, bad
paper, etc. Their skills are well-suited to index
arbitrage.
 
 
What is the role of liquidity in enabling good
derivatives markets?
 
The role of liquidity (which is defined as low
transactions costs) is in making arbitrage cheap
and convenient. If transactions costs are low,
then the smallest mispricings on the derivatives
market will be removed by arbitrageurs, which
will make the derivatives market more efficient.
 
 
What should a market index be?
 
A market index is a large, well-diversified
portfolio which is an approximation to returns
obtained in owning \the overall economy".
Portfolio diversification is a powerful means of
stripping out firm- and industry-effects, so that
the returns on the well-diversified portfolio reflect
only economy-wide effects, and are relatively
insensitive to the specific companies or industries
in the index portfolio. Market index returns time-
series are central to modern financial economics,
and have enormous value for a variety of real-
world applications. A good market index should
be highly liquid to support products in the real
world, it should have a high hedging effectiveness
against a huge variety of real-world portfolios,
and it should be hard to manipulate. 
 
 
What is special about Nifty for use in index
derivatives?
 
The methodology created for the NSE-50 index
explicitly isolates a set of securities for which the
market impact cost is minimised when buying or
selling the entire index portfolio. This makes Nifty
well-suited to applications such as index funds,
index derivatives, etc. Nifty has a explicit
methodology for regular maintenance of the
index set. It is successful at expressing the
market risk inherent in a wide variety of portfolios
in the country.
 
 
How does this low impact cost matter?
 
As is the case in all areas of finance, in the
context of index derivatives, there is a direct
mapping between transactions costs and market
efficiency. Index futures and options based on
Nifty will benefit from a high degree of market
efficiency because arbitrageurs will face low
transactions costs when they eliminate
mispricings. This high degree of market efficiency
on the index derivatives market will make it more
attractive to pure users of the derivatives, such
as hedgers, speculators and investors. High
liquidity also immediately implies that the index is
hard to manipulate, which helps engender public
confidence.
 
 
At the operational level, how do security
contracts compare versus index-based
contracts?
 
The basic fact is that index-based contracts
attract a much more substantial order-flow, which
helps them have tighter spreads (i.e. greater
liquidity). At a more basic economic level, we say
that there is less asymmetric information in the
index (as opposed to securities, where insiders
typically know more than others), which helps
index-based trading have better liquidity.
 
At settlement, in the case of security-options,
there is the possibility of delivery, and in that
case arises the question of depository vs. physical
delivery. Both alternatives are quite feasible.
However, in index-based contracts, that question
does not arise since all index-based contracts are
cash-settled.
 
The index has much less volatility than individual
securities. That helps index options have lower
prices, and index futures can work with lower
margins.
 
The most important difference between the index
and individual securities concerns manipulation.
Given that an index is carefully built with liquidity
considerations in mind, it is much harder to
manipulate the index as compared with the
difficulty of manipulating individual securities. 
 
 
How do I start trading in the index and stock
derivatives (futures and options) market?
 
Futures/ Options contracts in both index as well
as stocks can be bought and sold through the
trading members of National Stock Exchange.
Some of the trading members also provide the
internet facility to trade in the futures and options
market. You are required to open an account with
one of the trading members and complete the
related formalities which include signing of
member-constituent agreement, constituent
registration form and risk disclosure document.
The trading member will allot to you an unique
client identification number. To begin trading, you
must deposit cash and/or other collaterals with
your trading member as may be stipulated by
him.
 
 
What is the Expiration Day for Stocks or
Index futures and options?
 
It is the last day on which the contracts expire.
Index / Stock Futures and Options
contracts expire on the last Thursday of the
expiry month. If the last Thursday is a trading
holiday, the contracts expire on the previous
trading day. 
 
 
What is the contract cycle for Equity based
products in NSE ?
 
Futures and Options contracts have a maximum
of 3-month trading cycle -the near month (one),
the next month (two) and the far month (three).
New contracts are introduced on the trading day
following the expiry of the near month contracts.
The new contracts are introduced for a three
month duration. This way, at any point in time,
there will be 3 contracts available for trading in
the market (for each security) i.e., one near
month, one mid month and one far month
duration respectively. For example on January
26,2008 there would be three month contracts
i.e. Contracts expiring on January 31,2008,
February 28, 2008 and March 27, 2008. On
expiration date i.e January 31, 2008, new
contracts having maturity of April 24,2008 would
be introduced for trading.
 
 
What are mini- derivative contract and what
are the uses of it?
 
The minimum contract size for the mini derivative
contract on Nifty Index is Rs. 1 lakh. The contract
of Nifty index with this contract size is known as
the mini derivative contract. The lower minimum
contract size enables smaller investors / retail
investors to participate and hedge their portfolio
using these contracts.
 
 
What is meant by longer dated derivatives
products? Why longer dated index options
are required?
 
Longer dated derivatives products are useful for
those investors who want to have a long term
hedge or long term exposure in derivative
market. The premiums for longer term
derivatives products are higher than for standard
options in the same stock because the increased
expiration date gives the underlying asset more
time to make a substantial move and for the
investor to make a healthy profit. Currently,
longer dated options on Nifty with tenure of upto
3 years are available for the investors.
 
 
What is meant by a volatility Index and how
is it computed?
 
Volatility Index is a measure of expected stock
market volatility, over a specified time period,
conveyed by the prices of stock / index options. 
 
 
What is the concept of In the money, At the
money and Out of the money in respect of
Options?
 
In- the- money options (ITM) - An in-the-
money option is an option that would lead to
positive cash flow to the holder if it were
exercised immediately. A Call option is said to be
in-the-money when the current price stands at a
level higher than the strike price. If the Spot price
is much higher than the strike price, a Call is said
to be deep in-the-money option. In the case of a
Put, the put is in-the-money if the Spot price is
below the strike price.
 
At-the-money-option (ATM) – An at-the
money option is an option that would lead to zero
cash flow if it were exercised immediately. An
option on the index is said to be "at-the-money"
when the current price equals the strike price.
 
Out-of-the-money-option (OTM) - An out-of-
the-money Option is an option that would lead to
negative cash flow if it were exercised
immediately. A Call option is out-of-the-money
when the current price stands at a level which is
less than the strike price. If the current price is
much lower than the strike price the call is said to
be deep out-of-the money. In case of a Put, the
Put is said to be out-of-money if current price is
above the strike price.
 
 
What is the meant by lot size of contract in
the equity derivatives market? 
 
Lot size refers to number of underlying securities
in one contract. The lot size is determined
keeping in mind the minimum contract size
requirement at the time of introduction of
derivative contracts on a particular underlying.
For example, if shares of XYZ Ltd are quoted at
Rs.1000 each and the minimum contract size is
Rs.2 lacs, then the lot size for that particular
scrips stands to be 200000/1000 = 200 shares
i.e. one contract in XYZ Ltd. covers 200 shares.
 
 
Is there any Margin payable?
 
Yes. Margins are computed and collected on-line,
real time on a portfolio basis at the client level.
Members are required to collect the margin
upfront from the client & report the same to the
Exchange.
 
 
How are the contracts settled in case of
Index / Stock Futures and Options?
 
All the Index / Equity futures and options
contracts are settled in cash on a daily basis and
at the expiry or exercise of the respective
contracts as the case may be. Clients/Trading
Members are not required to hold any stock of
the underlying for dealing in the Futures /
Options market. All out of the money and at the
money option contracts of the near month
maturity expire worthless on the expiration date.
 
 
What are the Contract Specifications of
Index / Stocks based derivatives traded in
NSE?

Inde Inde Futu Opti Mini Mini Long

Para
x x res ons Inde Inde Term
mete
Futu Opti on on x x Inde
r
 res ons Indiv Indiv Futu Opti
idual idual res ons Opti
Secu Secu ons
rities rities
Under 5 5 179 179 S&P S&P S&P
lying indic indic securi securi CNX CNX CNX
es es ties ties Nifty Nifty Nifty
Optio - CE / - CA / - CE / CE /
n PE PA PE
Type
Strike - Strik - Strike - Strik Strik
Price e Price e
Price Price Price
Tradi 3 month trading cycle - the near month Three
ng (one), the next month (two) and the quart
Cycle far month (three) erly
expiri

(Marc
 June,
Sept

Dec
cycle
) and
next
5 half
yearl

expiri

(Jun,
Dec
cycle

Expiry Last Thursday of the expiry month. If the last

Day Thursday is a trading holiday, then the expiry
day is the previous trading day.
Strike - Depe - Depe - Depe Depe
Price nding nding nding nding
Interv on on on on
als unde under unde under
rlying lying rlying lying
price price price price
Price Rs.0. Rs.0. Rs.0. Rs.0. Rs.0. Rs.0. Rs.0.
Steps 05 05 05 05 05 05
Price Oper Uppe Oper Upper Oper Uppe Uppe
Bands ating r ating Oper ating r r
rang Oper range ating rang Oper Oper
e of ating of Rang e of ating ating
10% Rang 20% e 10% Rang Rang
of e of the +99 of e e
the +99 base % of the +99 +99
base % of price base base % of % of
price base price price base base
price or price price
or Rs.20 or or
Rs.2 , Rs.2 Rs.20
0, which 0, ,
 whic ever whic which
hever is heve ever
is highe r is is
highe r; highe highe
r; Lower r; r;
Lowe Oper Lowe Lowe
r ating r r
Oper Rang Oper Oper
ating e ating ating
Rang Rs.0. Rang Rang
e 05 e Rs. e Rs.
Rs.0. 0.05 0.05
05
 
 
What are the risks associated with trading in
Derivatives?
 
Investors must understand that investment in
derivatives has an element of risk and is
generally not an appropriate avenue for someone
with limited resources/ limited investment and /
or trading experience and low risk tolerance. An
investor should therefore carefully consider
whether such trading is suitable for him or her in
the light of his or her financial condition. An
investor must accept that there can be no
guarantee of profits or no exception from losses
while executing orders for purchase and / or sale
of derivative contracts, Investors who trade in
derivatives at the Exchange are advised to
carefully read the Model Risk Disclosure
Document and the details contained therein. This
document is given by the broker to his clients and
must be read, the implications understood and
signed by the investor. The document clearly
states the risks associated with trading in
derivatives and advises investors to bear utmost
caution before entering into the markets.
 
 
What is meant by currency futures?
 
Currency futures can be described as contracts
between the sellers and buyers whose values are
derived from the underlying Exchange Rate.
Currency derivatives are mostly designed for
hedging purposes, although they are also used as
instruments for speculation.
 
 
Currency futures trading is allowed in which
currency pairs?
 
Currency future trading is allowed in the US dollar
– Indian Rupee (USD – INR); Great Britain Pound
– Indian Rupee (GBP – INR), Euro – Indian Rupee
(EURO-INR) and Japanese Yen – Indian Rupee
(JPY-INR). 
 
 
Who can trade in the Currency Futures
Market?
 
Except FIIs and NRIs, every
individual/corporate/institution/bank etc. is
allowed to trade in the Currency Futures market.
 
 
What is the permitted lot size in case of
Currency futures?
 
Permitted lot size for USDINR future contracts is
1000 US dollars. Members place orders in terms
of number of lots. Therefore, if a member wants
to take a position for 10000 USD, then the
number of contracts required is 10000/1000 = 10
contracts.
 
 
How do I start trading Currency futures at
NSE?
 
Currency futures can be bought and sold through
the trading members of NSE. To open an account
with a NSE trading member, you will be required
to complete the formalities which include signing
of member constituent agreement, constituent
registration form and a risk disclosure document.
The trading member will allot you a unique client
identification number. To begin trading, you will
be required to deposit cash or collateral with your
trading member as may be stipulated by them.
 
 
What are the contract specifications for
Currency futures traded at NSE?

USDIN EURIN GBPIN JPYINR

Symbol
R R R
Market Type N N N N
Instrument FUTCU FUTCU FUTCU FUTCU
Type R R R R
Unit of 1-1 1-1 1-1 1-1
trading unit unit unit unit
denote denote denote denote
 s 1000 s 1000 s 1000 s
USD. EURO. POUND 10000
STERLI 0
NG . JAPAN
ESE
YEN.
Underlying / The The The The
Order exchan exchan exchan exchan
Quotation ge rate ge rate ge rate ge rate
in in in in
Indian Indian Indian Indian
Rupee Rupee Rupee Rupees
s for s for s for for 100
US Euro. Pound Japane
Dollars Sterlin se Yen.
g.
Tick size Rs.0.25 paise  or INR 0.0025
Trading Monday to Friday 
hours 9:00 a.m. to 5:00 p.m.
Contract 12 month trading cycle.
trading cycle
Last trading Two working days prior to the
day last business day of the expiry
month at 12 noon.
Final Last working day (excluding
settlement Saturdays) of the expiry month.
day The last working day will be the
same as that for Interbank
Settlements in Mumbai.
Quantity 10,001 or greater
Freeze
Base price Theore Theore Theore Theore
tical tical tical tical
price price price price
on the on the on the on the
1st 1st 1st 1st
day of day of day of day of
the the the the
contra contra contra contrac
ct. ct. ct. t.
 On all On all On all On all
other other other other
days, days, days, days,
DSP of DSP of DSP of DSP of
the the the the
contra contra contra contrac
ct. ct. ct. t.
Price Tenur +/-3 % of base price.
opera e
ting upto
range 6
mont
hs
Tenur +/- 5% of base price.
e
great
er
than
6
mont
 hs
Positi Client higher higher higher higher
on s of 6% of 6% of 6% of 6%
limits of total of total of total of total
open open open open
interes interes interes interes
t or t or t or t or
USD EURO GBP 5 JPY
10 5 million 200
million million million
Tradi higher higher higher higher
ng of 15% of 15% of 15% of 15%
Memb of the of the of the of the
ers total total total total
open open open open
interes interes interes interes
t or t or t or t or
USD EURO GBP JPY
50 25 25 1000
million million million million
 Bank higher higher higher higher
s of 15% of 15% of 15% of 15%
of the of the of the of the
total total total total
open open open open
interes interes interes interes
t or t or t or t or
USD EURO GBP JPY
100 50 50 2000
million million million million
Initial SPAN Based Margin
margin
Extreme loss 1% of 0.3% 0.5% 0.7%
margin MTM of MTM of MTM of MTM
value value value value
of of of of
gross gross gross gross
open open open open
positio positio positio positio
n n n n
Calendar Rs.400 Rs.700 Rs.150 Rs.600
spreads for for 0 for for
spread spread spread spread
of 1 of 1 of 1 of 1
month month month month
Rs.500 Rs.100 Rs.180 Rs.100
for 0 for 0 for 0 for
spread spread spread spread
of 2 of 2 of 2 of 2
month month month month
s s s s
Rs.800 Rs.150 Rs.200 Rs.150
for 0 for 0 for 0 for
spread spread spread spread
of 3 of 3 of 3 of 3
month month month month
s s and s and s and
Rs.100 more more more
0 for
 spread
of 4
month
s and
more
Settlement Daily settlement  :  T + 1
Final  settlement :  T + 2
Mode of Cash settled in Indian Rupees
settlement
Daily Calculated on the basis of the
settlement last half an hour weighted
price average price.
(DSP)
Final RBI RBI Exchan Exchan
settlement referen referen ge rate ge rate
price ce rate ce rate publish publish
(FSP) ed by ed by
RBI in RBI in
its its
Press Press
 Releas Releas
e e
caption caption
ed RBI ed RBI
referen referen
ce ce
Rate Rate
for for
US$ US$
and and Eu
Euro
 
 
What is the Settlement price for currency
futures ?
 
The settlement price is the Reserve Bank of India
Reference Rate on the last trading day. 
 
 
How is Settlement mechanism done in
Currency futures?
 
The currency futures contracts are settled in cash
in Indian Rupee.
 
 
What is the final settlement day in case of
currency futures ?
 
Final settlement day is the last working day
(subject to holiday calendars) of the month. The
last working day is taken to be the same as that
for Inter-bank Settlements in Mumbai. The rules
for Inter-bank Settlements, including those for
‘known holidays’ and ‘subsequently declared
holiday’ are those laid down by FEDAI (Foreign
Exchange Dealers Association of India). In
keeping with the modalities of the OTC markets,
the value date / final settlement date for the each
contract is the last working day of each month
and the reference rate fixed by RBI two days
prior to the final settlement date is used for final
settlement. The last trading day of the contract is
therefore 2 days prior to the final settlement
date. On the last trading day, since the
settlement price gets fixed around 12:00 noon,
the near month contract ceases trading at that
time (exceptions: sun outage days, etc.) and the
new far month contract is introduced.
 
 
What is meant by Interest Rate Futures? 
 
An interest rate futures contract is "an agreement
to buy or sell a debt instrument at a specified
future date at a price that is fixed today." 
 
 
What is the underlying for Interest Rate
Futures?
 
Currently, exchange traded Interest rate futures
are based on the notional coupon bearing GOI
security. 
 
While the name ‘interest rate futures’
suggests that the underlying is interest rate,
it is actually bonds that form the underlying
instruments. An important point to note is that
the underlying bond in India is a “notional”
government bond which may not exist in reality.
The underlying for bond futures in India is a
notional 10 year government bond with a coupon
payment of 7% p.a. In India, the RBI and the
SEBI have defined the characteristics of this
bond: maturity period of 10 years and coupon
rate of 7% p.a.
 
 
Why a Notional Bond is being used as
Underlying?
 
Currently, the underlying for bond futures in India
is a notional 10 year government bond with a
coupon payment of 7% p.a. Such a bond may not
actually exist. So, let us understand why such a
notional underlying has been selected.
 
If futures were to be introduced on each of the
government bonds, then there would be a large
number of interest rate futures contracts trading
on each bond and as a result, the liquidity would
be poor for many of these futures. So a single
bond futures has been identified which pays 7%
p.a. as coupon rate and has maturity of 10 years.
All bonds have been assigned a multiplier called
‘conversion factor’ which brings that bond on par
with the theoretical bond available for trading.
We will learn more about the conversion factor in
subsequent sections.
 
If the bond future were to be based on an actual
bond issue, it could potentially raise the activity
in the futures market to such a large extent as to
cause severe shortages of this actual bond for
delivery at expiry. To avoid this danger of
shortages to meet the delivery requirement, the
Exchange allows a specific set of bonds--rather
than a single bond--with different coupons and
expiry dates to be used for satisfying the
obligations of short position holders in a contract.
Thus, while the purpose of a notional underlying
bond is to ensure liquidity, the purpose of having
a basket of bonds is to ensure that there delivery
is not affected by short supply, which would have
arisen in case of a single bond. 
 
 
Why has the bond with a 7% coupon rate
been chosen? 
 
The coupon rate of 7 % has been chosen for the
hypothetical bond because the yields on
government bonds are generally close to 7 % and
hence there would not be much difference in yield
between the delivered bond and the hypothetical
underlying.
 
 
How is the settlement done in case of
Interest Rate futures?
 
The interest rate futures have to be physically
settled unlike the equity derivatives which are
cash settled in India. Physical settlement entails
actual delivery of a bond by the seller to the
buyer. But because the underlying notional bond
may not exist, the seller is allowed to deliver any
bond from a basket of deliverable bonds identified
by the authorities.
 
 
What are the uses of Interest Rate futures?
 
It is not just the financial sector, but also the
corporate and household sectors that are exposed
to interest rate risk. Banks, insurance companies,
primary dealers and provident funds bear
significant interest rate risk on account of the
mismatch in the tenure of their assets (such as
loans and Govt. securities) and liabilities. These
entities therefore need a credible institutional
hedging mechanism. Interest rate risk is
becoming increasingly important for the
household sector as well, since the interest rate
exposure of several households are rising on
account of increase in their savings and
investments as well as loans (such as housing
loans, vehicle loans etc.). Moreover, interest rate
products are the primary instruments available to
hedge inflation risk, which is typically the single
most important macroeconomic risk faced by the
household sector. It is therefore important that
the financial system provides different agents of
the economy a greater access to interest rate risk
management tools such as exchange-traded
interest rate derivatives.
 
 
Who can participate in the Interest Rate
Futures market
 Banks and Primary Dealers
 Mutual Funds and Insurance Companies
 Corporate houses and Financial Institutions
 FIIs and NRIs
 Member Brokers and Retail Investors
 
How to participate in Interest Rate Futures
trading at NSE ?
 
Interest rate futures can be bought and sold
through the trading members of the National
Stock Exchange. To open an account with a NSE
trading member you will be required to complete
the formalities which include signing of member
constituent agreement, constituent registration
form and a risk disclosure document. The trading
member will allot you a unique client
identification number. To begin trading you will
be required to deposit cash or collateral with your
trading member as may be stipulated by them. 
 
 
What are the contract specifications for
Interest Rate futures traded at NSE?

Symbol 10YGS7
Market
Normal
Type
Instrumen
FUTIRD
t Type
1 lot – 1 lot is equal to
Unit of
notional bonds of FV
trading
Rs.2 lacs
10 Year Notional
Coupon bearing
Government of India
Underlying (GOI) security.
(Notional Coupon 7%
with semiannual
compounding.)
Rs.0.0025 or 0.25
Tick size
paise
Monday to Friday (On
Trading
all business days)
hours
9:00 a.m. to 5:00 p.m.
 Four fixed quarterly
contracts for entire
Contract
year, expiring in
trading
March, June,
cycle
September and
December.
Two business days
Last
preceeding the last
trading
business day of the
day
delivery month.
Delivery Last business day of
day delivery month
Daily Settlement -
Marked to market daily

Settlement
Final Settlement -
Physical settlement in
the delivery month
  
 
FEW BASIC STRATEGIES FOR EQUITY
FUTURES AND OPTIONS
 
Have a view on the market?
 
Case Assumption: Bullish on the market
1: over the short term Possible Action by
you: Buy Nifty calls
 
Example:
   
Current Nifty is 1880. You buy one
contract of Nifty near month calls for Rs.20
each. The strike price is 1900, i.e. 1.06%
out of the money. The premium paid by
you will be (Rs.20 * 50) Rs.1000.Given
these, your break-even Nifty level is 1920
(1900+20). If at expiration 
 

Nifty advances by 5%, i.e. 1974,

then
Nifty
expiration 1974.00
level 
Less Strike
1900.00
Price 
Option  (1974-
74.00
value  1900)
 Less
Purchase 20.00
price 
Profit per
54.00
Nifty 
Profit on
 (Rs. 54*
the Rs. 2,700
50)
contract 
  
Note:   

 
1) If Nifty is at or below 1900 at expiration,
the call holder would not find it profitable
to exercise the option and would loose the
entire premium, i.e. Rs.1000 in this
example. If at expiration, Nifty is between
1900 (the strike price) and 1920
(breakeven), the holder could exercise the
calls and receive the amount by which the
index level exceeds the strike price. This
would offset some of the cost.
 
2) The holder, depending on the market
condition and his perception, may sell the
call even before expiry.
 
Case Assumption: Bearish on the market
2: over the short term Possible Action by
you: Buy Nifty puts
 
Example:
   
Nifty in the cash market is 1880. You buy
one contract of Nifty near month puts for
Rs.17 each. The strike price is 1840, i.e.
2.12% out of the money. The premium
paid by you will be Rs.850 (17*50). Given
these, your break-even Nifty level is 1823
(i.e. strike price less the premium). If at
expiration Nifty declines by 5%, i.e.1786,
then
 

Put Strike Price 1840

Nifty
expiration 1786
level 
Nifty
expiration 1786
level 
Option  (1840-
54
value  1786)
Less
Purchase 17
price 
 Profit per
37
Nifty 
Profit on
 (Rs.37*
the Rs.1850
50)
contract 
  
Note:   

 
1) If Nifty is at or above the strike price 1840
at expiration, the put holder would not find
it profitable to exercise the option and
would loose the entire premium, i.e.
Rs.850 in this example. If at expiration,
Nifty is between 1840 (the strike price)
and 1823 (breakeven), the holder could
exercise the puts and receive the amount
by which the strike price exceeds the index
level. This would offset some of the cost.
 
2) The holder, depending on the market
condition and his perception, may sell the
put even before expiry.
 
 
Use Put as a portfolio Hedge?
 
Assumption: You are concerned about a
downturn in the short term in the market and its
effect on your portfolio. The portfolio has
performed well and you expect it to continue to
appreciate over the long term but would like to
protect existing profits or prevent further losses.
 
Possible Action: Buy Nifty puts.
 
Example:
 
You held a portfolio with say, a single stock, HLL
valued at Rs. 10 Lakhs (@ Rs.200 each share).
Beta of HLL is 1.13. Current Nifty is at 1880. Nifty
near month puts of strike price 1870 is trading at
Rs. 15. To hedge, you bought 3 puts 600{Nifties,
equivalent to Rs.10 lakhs*1.13 (Beta of HLL) or
Rs. 1130000}. The premium paid by you is
Rs.9000, (i.e.600 * 15). If at expiration Nifty
declines to 1800, and Hindustan Lever falls to
Rs.195, then

Put Strike
1870
Price 
Nifty
expiration 1800
level 
 (1870-
Option value  70
1800)
Less
Purchase 15
price
Profit per
55
Nifty 
Profit on the  (Rs.55*
Rs.33000
contract  600)
Loss on
Hindustan Rs.25000
Lever
Net profit  Rs. 8000
 
 
FEW BASIC TRADING STRATEGIES FOR
CURRENCY FUTURES

Case 1: View INR will depreciate against

USD caused by India’s sharply rising import
bill and poor FII equity inflows:

Trade:
USD-INR 31 July 08
43.50000
contract 
Current spot rate (9
43.0000
July 2008) 
Value Rupees 43,2500
Buy 1 July contract 
(USD 1000*43.5000)
Hold contract to RBI fixing rate on 29
expiry  July 08 – 44.0000
Profit – Rupees 500
Economic Return 
(44,000 – 43,500)
  
Case 2: Expecting a remittance for USD 1000
on 29 August 08. Want to lock in the FX rate
today.

Trade:
USD-INR 29 Aug 08 44.2500
contract  
Current Spot rate (9 43.0000
July 08) 
Sell 1 Aug Contract  Value Rupees 44,250
Expiry Date  RBI fixing rate on 27
Aug 08 – 44.0000
Sell USD 1000 in the
Spot OTC market at
44.0000
Economic Return  Profit – Rupees 250
(44,250-44,000) 
Effective Rate of
Remittance 44.2500 
While spot on the date
was 44.0000
  
Case 3: Investment offshore for USD 1000
on 31 July 2008. Also want to keep FX
exposure hedged for a month after that.
 
Trade:
USD-INR 31 Aug 08 43.5000 
contract 
USD-INR 29 Aug 08 44.2500
contract
Current Spot rate (9 July 43.0000
08)
Buy 1 Jul contract  43.5000
Sell 1 Aug contract  44.2500
Expiry of Jul Contract  RBI fixing rate on 29 July
08 – 44.0000
Buy USD 1000 in the Spot
OTC market at 44,000
invest offshore 
Expiry of Aug Contract  Sell offshore investment
RBI fixing rate on 27 Aug
08 – 44.0000 Sell USD
1000 IN Spot OTC market
at 44.0000
Economic Return  Jul contract : Rupees 500
( 44,000 – 43, 500)
Aug contract  Rupees 250 (44,250 –
44,000)
Note: Return on offshore investment can be
hedged in addition to initial investment amount.
 
 
FEW BASIC STRATEGIES FOR TRADING IN
INTEREST RATE FUTURES

Case: 1 Directional trading

A trader expects a long term interest rate to rise.

He decides to sell interest rate futures contracts
as he shall benefit from rising future prices. 
 

 
 Trade Date- 1st July 09 
 Futures Delivery date – 1st Sep 2009
 Current Futures Price- 97.50
 Futures Bond Yield- 7.21%
 Trader sell 250 contracts of the Sep 09 10
Year futures contract on NSE on 1st July 2009
at 97.50
Daily MTM due to change in futures price is as
tabulated below

Daily
MTM
Date Settlement Calculation
(Rs)
Price*
1-
250*2000*(97.50- -
Jul- 97.75
97.75) 125000
09
2-
250*2000*(97.75-
Jul- 97.25 250000
97.25)
09
3-
250*2000*(97.25-
Jul- 97.00 125000
97.00)
09
6-
250*2000*(97.00- -
Jul- 97.25
97.25) 125000
09
 
Net MTM gain as on 6th July 09 is INR 1, 25,000
(I)

* Daily Settlement price shall be the weighted

average price of the trades in the last ½ hour of
trading. 
 
 
Closing out the Position
 7th July 2009- Futures market Price – 96.60
 Trader buys 250 contracts of Sep 09 at 96.60
 and squares off its position
 Therefore total profit for trader
250*2000*(97.25-96.60) is Rs.3,25,000 (II)
 Total Profit on the trade = INR 4,50,000 (I &
II)
Case 2: Hedging 
 
A bank has a large portfolio of GOI securities
worth INR 25 crores. Bank’s portfolio consists of
bonds with different coupons and different
maturities. 
 
In view of rising interest rates in the near term.
The treasury head has concern that rise in
interest rate shall negatively affect the value of
his portfolio in GOI securities. The treasury head
wants to hold his entire portfolio and at the same
time doesn’t want to suffer losses on account of
fall in bond prices. 
 
Should the bank go short or long on the futures
contracts to establish the correct hedge?
 
The treasury head decides to hedge the interest
rate risk by taking a short position in the interest
rate futures on NSE. 
 
 
Case 3: Calendar Spread Trading
 
A long & short position in different futures
contracts on the same underlying is called as a
calendar spread.
 
If a long position in a Sep 09 IRF contract versus
a short position in the Dec 09 IRF contract on
NSE is considered a calendar spread.
 
Since a calendar spread entails only the basis
risk, the bank runs little risk on the positions. 
 
Example:

Trade 6th July

   : 
Date ’09
100.20
Sept ’09
   :  –
Futures
100.22
Dec ’09 99.90 –
   : 
Futures 99.95
 
The difference between the Sep 09 & Dec 09
contracts is currently Rs. 0.25 (after considering
bid- ask). If the trader believes that this spread is
very high, he would execute a calendar spread by
 
Buying the Dec09 futures at 99.95
 
Selling the Sep09 futures at 100.20
 
10 days later

Trade 16th
   : 
Date July ’09
101.35
Sept ’09
 :  –
Futures
100.37
101.20
Dec ’09
 :  –
Futures
101.27
 
The difference between the Sep 09 & Dec 09
contracts is now Rs. 0.17 (after considering bid-
ask). 
 
The trader may decide to liquidate his calendar
spread trade by
 
Selling the Dec futures at 101.20 (Profit 1.25)
 
Buying the Sept futures at 100.37 (Loss 0.17)
 
Net profit of Rs. 1.08 without running any
interest rate risk
 
 
Case 4. Arbitrage Trading
 
The price differential in the underlying bond
market and the future market can also provide
opportunities to arbitragers. If the futures are
expensive compared to the underlying then
arbitrager can make profit by taking long position
in underlying market by borrowing funds and
taking short positions in the future market. This is
explained with following example. 
 
On 15th July, 09 buy 6.35% GOI ’20 at the
current market price of Rs. 97.2550
 
Step Short the futures at the current futures price
1 - of 100.00 (7.00% Yield)
 
Step Fund the bond by borrowing up to the
2 - delivery period (assuming borrowing rate is
4.25%)
 
Step On 1st Sept ’09, give a notice of delivery to
3 - the exchange 
 
Assuming the futures settlement price of
100.00, the invoice price would be
  
= 100 * 0.9815 
 
= 98.15
 
Under the strategy, the bank has earned a
return of 
 
= (98.1500 – 97.2550) / 97.2550 * 365 / 48
 
= 7.00 % (implied repo rate)
Note: For simplicity accrued interest is not
considered for calculation
 
Against its funding cost of 4.25% (borrowing
rate), thereby earning risk free arbitrage
 
The bond with the highest implied repo rate
would be the cheapest to deliver (CTD) bond
 
The arbitrager would identify the bond with the
highest implied repo rate or the CTD bond and
execute the strategy with the same bond,
depending on its availability in the secondary
market
 Source: BSE

BASICS OF DERIVATIVES
1. What are derivative instruments?
A derivative is an instrument whose value is
derived from the value of one or more underlying,
which can be commodities, precious metals,
currency, bonds, stocks, stocks indices, etc. Four
most common examples of derivative instruments
are Forwards, Futures, Options and Swaps.
 
2. What are Forward contracts?
A forward contract is a customized contract
between two parties, where settlement takes
place on a specific date in future at a price agreed
today. The main features of forward contracts are
 They are bilateral contracts and hence
exposed to counter-party risk.
 Each contract is custom designed, and hence
is unique in terms of contract size, expiration
date and the asset type and quality.
 The contract price is generally not available in
public domain.
 The contract has to be settled by delivery of
the asset on expiration date.
 In case, the party wishes to reverse the
contract, it has to compulsorily go to the
same counter party, which being in a
monopoly situation can command the price it
wants.
3. What are Futures ?
Futures are exchange-traded contracts to sell or
buy financial instruments or physical commodities
for Future delivery at an agreed price. There is an
agreement to buy or sell a specified quantity of
financial instrument/ commodity in a designated
Future month at a price agreed upon by the
buyer and seller. To make trading possible, the
exchange specifies certain standardized features
of the contract.  
 
4. What is the difference between Forward
contracts and Futures contracts ?

Sr.
Basis Futures Forwards
No.
Traded on
Over the
1 Nature organized
Counter
exchange
Contract
2 Standardized Customised
terms
3 Liquidity More Liquid Less Liquid
Requires
Margin
4 Margin Not required
Payments
Payments
Follows daily At the end of
5 Settlement
settlement the period.
6 Squaring Can be Contract can be
off reversed with reversed only
 with the same
counter-party
any member of
with whom it
the exchange.
was entered
into.
  
  
INDEX FUTURES
1. What is the underlying for INDEX
futures ?
The underlying for the INDEX futures is the
corresponding BSE Index. For e.g. the underlying
for SENSEX futures is BSE Sensitive Index of 30
scrips, popularly called the SENSEX.  
 
2. What is the contract multiplier ?
The contract multiplier is the minimum number of
the underlying - index or stock that a participant
has to trade while taking a position in the
Derivatives Segment.As of May 2008, the
contract multiplier for SENSEX is 15. This means
that the Rupee notional value of a sensex futures
contract would be 15 times the contracted value.
The following table gives a few examples of this
notional value.

Contracted Notional Value in Rs.

 Price ( based on Market Lot of 15
of Futures )
17800 267000
17850 267750
17900 268500
17950 269250
18000 270000
It may be mentioned here that the market lot
may be changed by the Exchange in consultation
with the NSE as per the SEBI guidelines on the
same.  
 
3. What is the ticker symbol and trading
hours ?
The ticker symbol is the selected alphabets of the
underlying for e.g. the ticker for BSE Sensex is
BSX while that for the Sensex 'mini' contract is
MSX, for Reliance Industries Ltd., it is RIL, etc.
The trading timings for the Derivatives Segment
of BSE are the same as that in the Equity
Segment - from 9:55 a.m. to 3:30 p.m. (except
in cases of Sun Outage when the timings are
extended on account of a halt in trading during
the day). Trading session's timings can be viewed
at the Calendars Section.  
 
4. What is the maturity of the futures
contract ?
Presently, SEBI has permitted Exchanges to offer
futures products of 1 month, 2 months and 3
months maturity only on a rolling basis- e.g. say
for May, June and July months. When the May
contract expires there will be a fresh contract
month available for trading viz. the August
contract. These months are called the Near
Month, Middle Month and Far Month respectively.
On 9th June 2000, when Equity Derivatives were
first introduced in India at the Bombay Stock
Exchange, we started with the three monthly
series for June, July and August 2000.
 
5. What is the tick size ?
This means that the minimum price fluctuation in
the value of a contract the tick size is presently
"0.05" or 5 paisa. In Rupee terms, this translates
to a minimum price fluctuation of Rs. 0.75 for a
single transaction of SENSEX Futures Contract
(Tick size X Contract Multiplier = 0.05 X Rs. 15).
 
6. How is the final settlement price
determined ?
The closing value of underlying Index of the cash
market is taken as the final settlement price of
the futures contract on the last trading day of the
contract for settlement purposes.
 
7. What is margin money ?
The aim of collecting margin money from the
client / broker is to minimize the risk of
settlement default by either counterparty. The
payment of margin ensures that the risk is limited
to the previous day's price movement on each
outstanding position. However, even this
exposure is offset by the initial margin holdings.
Margin money is like a security deposit or
insurance against a possible Future loss of value.
Once the transaction is successfully settled, the
margin money held by the exchange is released /
adjusted against the settlement liability.
 
8. Are there different types of Margin ?
Yes, there are different types of margin like Initial
Margin, Variation margin(commonly called Mark
to market or M -T- M) Exposure Margin and
Additional Margin, if any.
 
9. What is the objective of Initial margin ?
The basic aim of Initial margin is to cover the
largest potential loss in one day. Both buyer and
seller have to deposit margins. The initial margin
is deposited before the opening of the position in
the futures transaction. This margin is calculated
by SPAN by considering the worst case scenario.
 
10. What is Variation or Mark-to-Market
Margin ?
Variation or mark to market Margin is the daily
profit or loss obtained by marking the member's
outstanding position to the market (closing price
of the day) and receiving or paying the difference
from / to him in cash on the succeeding working
day.
 
11. What are long / short positions ?
In simple terms, long and short positions indicate
whether you have a buy position (long) or sell
position (short).
 
12. Is there a theoretical way of pricing
Index Future ?
The theoretical way of pricing any Future is to
factor in the current price and holding costs or
cost of carry. A Futures contract is normally by its
very definition for a specified period of time, at
the end of which it is settled. In order to
compensate the seller for waiting till expiry for
realizing the sale proceeds the buyer has to pay
some interest which is reflected in the form of
cost of carry.
In general, the Futures Price = Spot Price +
Cost of Carry.
Theoretically, the Cost of carry is the sum of all
costs incurred if a similar position is taken in cash
market and carried to maturity of the futures
contract less any revenue which may result in
this period. The costs typically include interest in
case of financial futures (also insurance and
storage costs in case of commodity futures). The
revenue may be dividends in case of index
futures.
Apart from the theoretical value, the actual value
may vary depending on demand and supply of
the underlying at present and expectations about
the future. These factors play a much more
important role in commodities, especially
perishable commodities than in financial futures.
In general, the futures price is greater than the
spot price (in case of a bullish sentiment in the
market). In special cases, when cost of carry is
negative (on account of a bearish view in the
market), the futures price may be lower than
Spot prices.
 
13. What is the concept of Basis?
The difference between Spot price and Futures
price is known as Basis. Although the Spot price
and Futures prices generally move in line with
each other, the basis is not constant. Generally
basis will decrease with time and on expiry, the
basis is zero as the Futures price equals Spot
price.
 
14. What are the profits and losses in case
of a futures position ?
The profits and losses would depend upon the
difference between the price at which the position
is opened and the price at which it is closed. Let
us take some examples.
Example 1
Position : Long - Buy June Sensex Futures @ 15500
Payoff : Profit - if the futures price goes up Loss - if the
futures price goes down
Calculation : The profit or loss would be equal to fifteen
times the difference in the two rates.
If June Sensex Futures is sold @ 15600 there
would be a profit of 100 points which is equal to
Rs. 1500 (100 X 15).
However if the June Sensex is sold @ 15450
there would be a loss of 50 points which is equal
to Rs. 750 (50 X 15)
Example 2
Position : Short Sell June Sensex Futures @ 15500
Payoff : Profit - if the futures price goes down Loss - if
the futures price goes up
Calculation : The profit or loss would be equal to fifteen
times the difference in the two rates.
If June Sensex Futures is bought @ 15700 there
would be a loss of 200 points which is equal to
Rs. 3,000 (200 X 15).
However if the June Sensex Futures is bought @
15400, there would be a profit of 100 points
which is equal to Rs. 15, 00 (100 X 15).
 
15. What happens to the profit or loss due to
daily settlement ?
In case the position is not closed the same day,
the daily settlement would alter the cash flows
depending on the settlement price fixed by the
exchange every day. However the net total of all
the flows every day would always be equal to the
profit or loss calculated above. Profit or loss
would only depend upon the opening and closing
price of the position, irrespective of how the rates
have moved in the intervening days.
Let us take the illustration where a long position
is opened at 15550 and closed at 15650 resulting
in a profit of 100 points or Rs. 1500
Let us assume that the daily closing settlement
prices are as shown.
 
Example 3
Daily Closing Settlement Prices
  Case 1
Day 1 15500
Day 2 15580
Day 3 15560
Day 4 15600
Position Closed 15650
 
Settlement Prices
Case 1
Calculation Profit/Loss
Position Opened -
     
Long @ 5550
Day 1 15500 15500 - 15550 -50
Day 2 15580 15580 - 15500 +80
Day 3 15560 15560 - 15580 -20
Day 4 15600 15600 - 15560 +40
Position Closed -
  15650 - 15600 +50
Short @ 15650
Profit / (Loss)     100
In all the cases the net result is a profit of 100
points, which is the difference between the
closing and opening price, irrespective of the
daily settlement price and different MTM flows.
 
16. How does the Initial Margin affect the
above profit or loss ?
The initial margin is only a security provided by
the client through the clearing member to the
exchange. It can be withdrawn in full after the
position is closed. Therefore it does not affect the
above calculation of profit or loss.
However there would be a funding cost /
transaction cost in providing the security. This
cost must be added to the total transaction costs
to arrive at the true picture. Other items in
transaction costs would include brokerage, stamp
duty etc.
 
17. What is a spread position ?
A calendar spread is created by taking
simultaneously two positions
a.A long position in a futures series expiring in
any calendar month
b.A short position in the same futures as 1
above but for a series expiring in any month
other than the 1 above.
Examples of Calendar Spreads
1. Long June Sensex Futures Short July
Sensex Futures
2. Short July Sensex Futures Long August
Sensex Futures
A spread position must be closed by reversing
both the legs simultaneously. The reversal of 1
above would be a sale of June Sensex Futures
while simultaneously buying the July Sensex
Futures.
 
 
STOCK FUTURES
1. What are Stock Futures ?
Stock Futures are financial contracts where the
underlying asset is an individual stock. Stock
Future contract is an agreement to buy or sell a
specified quantity of underlying equity share for a
future date at a price agreed upon between the
buyer and seller. The contracts have standardized
specifications like market lot, expiry day, and unit
of price quotation, tick size and method of
settlement.
 
2. How Stock Futures are priced ?
The theoretical price of a future contract is sum
of the current spot price and cost of carry.
However, the actual price of futures contract very
much depends upon the demand and supply of
the underlying stock. Generally, the futures prices
are higher than the spot prices of the underlying
stocks.
Futures Price = Spot Price + Cost of Carry
Cost of carry is the interest cost of a similar
position in cash market and carried to maturity of
the futures contract less any dividend expected
till the expiry of the contract.
Example:
Spot Price of Stock "A" = 3000, Interest Rate =
12% p.a.
Futures Price of 1 month contract = 3000 +
3000*0.12*30/365
= 3000 + 30
= 3030
 
3. How are Stock Futures different from
Stock Options ?
In stock options, the option buyer has the right
and not the obligation, to buy or sell the
underlying share. In case of stock futures, both
the buyer and seller are obliged to buy/sell the
underlying share.
Risk-return profile is symmetric in case of single
stock futures whereas in case of stock options
payoff is asymmetric.
Also, the price of stock futures is affected mainly
by the prices of the underlying stock whereas in
case of stock options, volatility of the underlying
stock affect the price along with the prices of the
underlying stock.
 
4 What are the opportunities offered by
Stock Futures ?
Stock futures offer a variety of usage to the
investors. Some of the key usages are mentioned
below:
Investors can take long term view on the
underlying stock using stock futures.
Stock futures offer high leverage. This means
that one can take large position with less capital.
For example, paying 20% initial margin one can
take positionfor 100 i.e. 5 times the cash outflow.
Futures may look overpriced or under priced
compared to the spot and can offer opportunities
to arbitrage or earn risk-less profit. Single stock
futures offer arbitrage opportunity between
stock futures and the underlying cash market. It
also provides arbitrage opportunity between
synthetic futures (created through options) and
single stock futures.
When used efficiently, single-stock futures can be
an effective risk management tool. For instance,
an investor with position in cash segment can
minimize either market risk or price risk of the
underlying stock by taking reverse position in an
appropriate futures contract.
 
5 How are Stock Futures settled ?
Presently, Stock futures are settled in cash. The
final settlement price is the closing price of the
underlying stock.
 
6. Can I square up my position ?
The investor can square up his position at any
time till the expiry. The investor can first buy and
then sell stock futures to square up or can first
sell and thenbuy stock futures to square up his
position. E.g. a long (buy) position in December
ACC futures, can be squared up by selling
December ACC futures.
 
7. When I am required to pay initial margin
to my broker ?
The initial margin needs to be paid to the broker
on an up-front basis before taking the position.
 
8. Do I have to pay mark to market margin ?
Yes. The outstanding positions in stock futures
are marked to market daily. The closing price of
the respective futures contract is considered for
marking to market. The notional loss / profit
arising out of mark to market is paid / received
on T+1 basis.
 
9. What are the profits and losses in case of
a stock futures position ?
The profits and losses would depend upon the
difference between the price at which the position
is opened and the price at which it is closed.Let
an investor have a long position of one November
Stock "A" Futures @ 430. If the investor square
up his position by selling November Stock "A"
futures @ 450, the profit would be Rs. 20 per
share. In case, the investor squares up his
position by selling November Stock "A" futures @
400, the loss would be Rs. 30 per share.  
 
10. What is the market lot for stock
futures ?
For market lot ands other details of the various
stock futures available on the exchange, please
visit the F&O List Section
 
11. Why are the market lots different for
different stocks ?
According to L C Gupta Committee Report on
Derivatives, at the time of introduction of
Derivatives Contracts on any underlying the value
of the contract should be at least Rs. 2 lakhs. This
value of Rs. 2 lakhs is divided by the market price
of the individual stock to arrive at the initial
'market lot' for it. It may be mentioned here that
the only exception to this rule is the 'mini'
contract on the Sensex (both futures and
Options).
The market lots are reviewed twice a year and
changes are made as per SEBI guidelines to re-
align the market lots in cases where the value
has increased / decreased drastically from the
value at the time of introduction / previous
review.
 
12. What are the different contract months
available for trading ?
1, 2 and 3 months contracts are presently
available for trading. However, in case of Sensex
Options, SEBI has allowed the introduction of
Long Dated Options or options with maturities of
up to 3 years.
 
13 What is spread trading on BSE ?
One can trade in spread contracts on the
Derivative Segment of BSE. Spreads are the
contracts for differential price. This means that in
case you want to buy a December contract and
sell November contract,you can enter an order for
Buy Nov Dec stating the difference you want to
pay. This would mean that you are buying a
December Contract & selling a November
contract.
Similarly, you can enter an order for Sell Nov Dec
stating the difference you want to receive. This
would mean that you are selling a December
Contract & buying a November Contract and
receiving the difference.
 
14. As an investor, how do I start trading in
Stock Futures ?
You need to first register yourself as a client with a
Registered Broker by fulfilling all the KYC or Know Your
Client rules. Then, sign up the client agreement form and
risk disclosure document provided to you by your broker.
Deposit upfront the initial margin
Now start trading!!
 
15. What securities can I submit to the
broker as collateral ?
You can pay initial margin in non-cash (bank guarantee,
securities) form also. This is an arrangement between
you and your broker, as to which securities he/she is
willing to accept. However, the mark-to-market loss
incurred on a daily basis has to be settled in cash, only.
 
16. How does an investor who has the
underlying stock, use stock futures when he
anticipates a short-term fall in stock price ?
The holder of the physical stock can sell a future
to avoid making a loss without having to sell the
share. Any loss caused by the fall in the price of
the stockis offset by gains made on the stock
future position.
 
17. How can an investor benefit from a
predicted rise or predicted fall in the price of
a stock ?
An investor can benefit from a predicted rise in
the price of a stock by buying futures. As the
price of the futures rises, the investor will make a
positive return. As the investor will have to pay
only the margin (which forms a fraction of the
notional value of contract), his return on
investment will be higher than on an equivalent
purchase of shares.
An investor can benefit from a predicted fall in
the price of stock by selling futures. As the price
of the future falls in line with the underlying
stock, the investor will make a positive return.
 
18. What is pair trading ?
This trading strategy involves taking a position on
the relative performance of two stocks. It is
achieved by buying futures on the stock expected
to perform well and selling futures on the stock
anticipated to perform poorly. The overall gain or
loss depends on the relative performance of the
two stocks.
Similarly it is possible to take a position in the
relative performance of a stock versus a market
index. For example traders who would like to take
only company specific risk could buy/sell the
relative index future.
 
 
OPTIONS ON SENSEX AND INDIVIDUAL
STOCKS
1. Important Terminology in Options ?
Option Premium : Premium is the price paid by
the buyer to the seller to acquire the right to buy
or sell.
Strike Price or Exercise Price : The strike or
exercise price of an option is the specified/
predetermined price of the underlying asset at
which the same can be bought or sold if the
option buyer exercises his right to buy/ sell on or
before the expiration day.
Expiration date : The date on which the option
expires is known as Expiration Date. On
Expiration date, either the option is exercised or
it expires worthless.
Exercise Date : The date on which the option is
actually exercised is called as Exercise Date.
In case of European Options the exercise date is
same as the expiration date while in case of
American Options, the options contract may be
exercised any day between the purchase of the
contract and its expiration date (see European/
American Option). In India , options on "Sensex"
are European style, whereas options on individual
are stocks American style.
Open Interest : The total number of options
contracts outstanding in the market at any given
point of time.
Option Holder : is the one who buys an option,
which can be a call, or a put option. He enjoys
the right to buy or sell the underlying asset at a
specified price on or before specified time.
His upside potential is unlimited while losses are
limited to the Premium paid by him to the option
writer.
Option seller/ writer : is the one who is
obligated to buy (in case of Put option) or to sell
(in case of call option), the underlying asset in
case the buyer of the option decides to exercise
his option. His profits are limited to the premium
received from the buyer while his downside is
unlimited.
Option Series: An option series consists of all
the options of a given class with the same
expiration date and strike price. e.g.
BSXCMAY15500 is an options series which
includes all Sensex Call options that are traded
with Strike Price of 15500 & Expiry in May. (BSX
Stands for BSE Sensex (underlying index), C is
for Call Option, May is expiry date & strike Price is
15500).
 
2. What is Assignment ?
When holder of an option exercises his right to
buy/ sell, a randomly selected (by computer)
option seller is assigned the obligation to honor
the underlying contract, and this process is
termed as Assignment.
 
3. What is European & American Style of
options ?
An American style option is the one which can be
exercised by the buyer at any time, till the
expiration date, i.e. anytime between the day of
purchase of the option and the day of its expiry.
The European kind of option is the one which can
be exercised by the buyer only on the expiration
day and & not any time before that.
 
4. What are Call Options ?
A call option gives the holder (buyer/ one who is
long call), the right to buy specified quantity of
the underlying asset at the strike price on or
before expiration date in case of American option.
The seller (one who is short call) however, has
the obligation to sell the underlying asset if the
buyer of the call option decides to exercise his
option to buy.
Example: An investor buys One European call
option on Stock "A" at the strike price of Rs. 3500
at a premium of Rs. 100. If the market price of
Stock "A" on the day of expiry is more than Rs.
3500, the option will be exercised. The investor
will earn profits once the share price crosses Rs.
3600 (Strike Price + Premium i.e. 3500+100).
Suppose stock price is Rs. 3800, the option will
be exercised and the investor will buy 1 share of
Stock "A" from the seller of the option at Rs 3500
and sell it in the market at Rs 3800 making a
profit of Rs. 200 {(Spot price - Strike price) -
Premium}.
In another scenario, if at the time of expiry stock
price falls below Rs. 3500 say suppose it touches
Rs. 3000, the buyer of the call option will choose
not to exercise his option. In this case the
investor loses the premium (Rs 100), paid which
shall be the profit earned by the seller of the call
option.
 
5. What are Put Options ?
A Put option gives the holder (buyer/ one who is
long Put), the right to sell specified quantity of
the underlying asset at the strike price on or
before an expiry date in case of American option.
The seller of the put option (one who is short Put)
however, has the obligation to buy the underlying
asset at the strike price if the buyer decides to
exercise his option to sell.
Example: An investor buys one European Put
option on Stock 'B' at the strike price of Rs. 300,
at a premium of Rs. 25. If the market price of
Stock 'B', on the day of expiry is less than Rs.
300, the option can be exercised as it is 'in the
money'. The investor's Break-even point is Rs.
275 (Strike Price - premium paid) i.e., investor
will earn profits if the market falls below 275.
Suppose stock price is Rs. 260, the buyer of the
Put option immediately buys Stock 'B' from the
market @ Rs. 260 & exercises his option selling
the Stock 'B' at Rs 300 to the option writer thus
making a net profit of Rs. 15 {(Strike price - Spot
Price) - Premium paid}.
In another scenario, if at the time of expiry,
market price of Stock 'B' is Rs 320; the buyer of
the Put option will choose not to exercise his
option to sell as he can sell in the market at a
higher rate. In this case the investor loses the
premium paid (i.e. Rs 25), which shall be the
profit earned by the seller of the Put option.  
 

  CALL OPTIONS PUT OPTIONS

Option Buys the right to Buys the right to
buyer or buy the underlying sell underlying
option asset at the asset at the
holder specified price specified price
Option Has the obligation Has the obligation
seller or to sell the to buy the
option underlying asset underlying asset
writer (to the option (from the option
holder) at the holder) at the
 specified price. specified price
 
6. How are options different from futures ?
The significant differences in Futures and Options
are as under:
 Futures are agreements/contracts to buy or
sell specified quantity of the underlying
assets at a price agreed upon by the buyer &
seller, on or before a specified time. Both the
buyer and seller are obligated to buy/sell the
underlying asset.
 In case of options the buyer enjoys the right
& not the obligation, to buy or sell the
underlying asset.
 Futures Contracts have symmetric risk profile
for both the buyer as well as the seller,
whereas options have asymmetric risk profile.
In case of Options, for a buyer (or holder of
the option), the downside is limited to the
premium (option price) he has paid while the
profits may be unlimited. For a seller or writer
of an option, however, the downside is
unlimited while profits are limited to the
premium he has received from the buyer.
 The Futures contracts prices are affected
mainly by the prices of the underlying asset.
The prices of options are however; affected
 by prices of the underlying asset, time
remaining for expiry of the contract, interest
rate & volatility of the underlying asset.
7. Explain "In the Money", "At the Money" &
"Out of the money" Options ?
An option is said to be "at-the-money", when the
option's strike price is equal to the underlying
asset price. This is true for both puts and calls.
A call option is said to be "in the money" when
the strike price of the option is less than the
underlying asset price. For example, a Stock A"
call option with strike of 3900 is "in-the-money",
when the spot price of Stock "A" is at 4100 as the
call option has a positive exercise value. The call
option holder has the right to buy the Stock "A"
at 3900, no matter by what amount the spot
price exceeded the strike price. With the spot
price at 4100, selling Stock "A" at this higher
price, one can make a profit.
On the other hand, a call option is out-of-the-
money when the strike price is greater than the
underlying asset price. Using the earlier example
of Sensex call option, if the Sensex falls to 3700,
the call option no longer has positive exercise
value. The call holder will not exercise the option
to buy Sensex at 3900 when the current price is
at 3700 and allow his "option" right to lapse.
 

  CALL OPTIONS PUT OPTIONS

Strike Price< Spot Strike Price > Spot
In-the-
Price of underlying Price of underlying
money
asset asset
Strike Price = Spot Strike Price = Spot
At-the-
Price of underlying Price of underlying
money
asset asset
Out-of Strike Price > Spot Strike Price< Spot
the- Price of underlying Price of underlying
money asset asset
 
A put option is in-the-money when the strike
price of the option is greater than the spot price
of the underlying asset. For example, a Stock "A"
put at strike of 4400 is in-the-money when the
spot price of Stock "A" is at 4100. When this is
the case, the put option has value because the
put option holder can sell the Stock "A" at 4400,
an amount greater than the current Stock "A" of
4100. Likewise, a put option is out-of-the-money
when the strike price is less than the spot price of
underlying asset. In the above example, the
buyer of Stock "A"put option won't exercise the
option when the spot is at 4800. The put no
longer has positive exercise value and therefore
in this scenario, the put option holder will allow
his "option" right to lapse.
 
8. What are Covered & Naked Calls ?
A call option position that is covered by an
opposite position in the underlying instrument
(for example shares, commodities etc),is called a
covered call. Writing covered calls involves
writing call options when the shares that might
have to be delivered (if option holder exercises
his right to buy), are already owned. E.g.A writer
writes a call on Reliance and at the same time
holds shares of Reliance so that if the call is
exercised by the buyer, he can deliver the stock.
Covered calls are far less risky than naked calls
(where there is no opposite position in the
underlying), since the worst that can happen is
that the investor is required to sell shares already
owned at below their market value. When a
physical delivery uncovered/ naked call is
assigned on exercise, the writer will have to
purchase the underlying asset to meet his call
obligation and his loss will be the excess of the
purchase price over the exercise price of the call
reduced by the premium received for writing the
call.
 
9. What is the Intrinsic Value of an option ?
The intrinsic value of an option is defined as the
amount, by which an option is in-the-money, or
the immediate exercise value of the option when
the underlying position is marked-to-market..
For a call option: Intrinsic Value = Spot Price -
Strike Price For a put option: Intrinsic Value =
Strike Price - Spot Price The intrinsic value of an
option must be a positive number or 0. It can'tbe
negative. For a call option, the strike price must
be less than the price of the underlying asset for
the call to have an intrinsic value greater than 0.
For a put option, the strike price must be greater
than the underlying asset price for it to have
intrinsic value.
 
10. Explain Time Value with reference to
Options ?
Time value is the amount option buyers are
willing to pay for the possibility that the option
may become profitable prior to expiration due to
favorable change in the price of the underlying.
An option loses its time value as its expiration
date nears. At expiration an option is worth only
its intrinsic value. Time value cannot be negative.

 
11. What are the factors that affect the
value of an option (premium)?
There are two types of factors that affect the
value of the option premium:
Quantifiable Factors:
 underlying stock price
 the strike price of the option
 the volatility of the underlying stock
 the time to expiration and
 the risk free interest rate
Non Quantifiable Factors:
 Market participants" varying estimates of the
underlying asset's future volatility
 Individuals" varying estimates of future
performance of the underlying asset, based
on fundamental or technical analysis
 The effect of supply & demand- both in the
options marketplace and in the market for the
underlying asset
 The "depth" of the market for that option -
the number of transactions and the contract's
 trading volume on any given day.
12. What are different pricing models for
options ?
The theoretical option pricing models are used by
option traders for calculating the fair value of an
option on the basis of the earlier mentioned
influencing factors. The two most popular option
pricing models are: Black Scholes Model which
assumes that percentage change in the price of
underlying follows a lognormal distribution.
Binomial Model which assumes that percentage
change in price of the underlying follows a
binomial distribution.
 
13. Who decides on the premium paid on
options & how is it calculated ?
Options Premium is not fixed by the Exchange.
The fair value/ theoretical price of an option can
be known with the help of pricing models & then
depending on market conditions the price is
determined by competitive bids & offers in the
trading environment. An option's premium / price
is the sum of Intrinsic value & time value
(explained above). If the price of the underlying
stock is held constant, the intrinsic value portion
of an option premium will remain constant as
 well. Therefore, any change in the price of the
option will be entirely due to a change in the
option's time value. The time value component of
the option premium can change in response to a
change in the volatility of the underlying, the
time to expiry, interest rate fluctuations, dividend
payments & to the immediate effect of supply &
demand for both the underlying & its option
 
14. Explain the Option Greeks ?
The price of an Option depends on certain factors
like price and volatility of the underlying, time to
expiry etc. The option Greeks are the tools that
measure the sensitivity of the option price to the
above-mentioned factors. They are often used by
professional traders for trading & managing the
risk of large positions in options & stocks. These
Option Greeks are:
                                 Delta : is the option Greek that
measures the estimated change in option premium/price
for a change in the price of the
                                                    underlying.

                                 Gamma : measures the estimated

change in the Delta of an option for a change in the price
of the underlying
                                 Vega : measures the estimated
change in the option price for a change in the volatility of
the underlying.
                                 Theta : measures the estimated
change in the option price for a change in the time to
option expiry.
                                 Rho : measures the estimated
change in the option price for a change in the risk free
interest rates.
                                 Volatility : A measure of stock price
fluctuation. Mathematically, volatility is the annualized
standard deviation of a stock's
                                                             daily price changes.

                                 Premium : is the price of an option

and is equal to its intrinsic value plus time value.
                                 Theoretical value : The estimated
value of an option derived from a mathematical model.
 
15. What is an Option Calculator ?
An option calculator is a tool to calculate the price
of an Option on the basis of various influencing
factors like the price of the underlying and its
volatility, time to expiry, risk free interest rate
etc. It also helps the user to understand how a
change in any one of the factors or more, will
affect the option price. The option calculator is
available at the Option Calculator Section.
 
16. Who are the likely players in the Options
Market ?
Developmental institutions, Mutual Funds,
Domestic & Foreign Institutional Investors,
Brokers, Retail participants are the likely players
in the Options Market.
 
17. Why should I invest in Options?What do
options offer me ?
Besides offering flexibility to the buyer in the
form of right to buy or sell, the major advantage
of options is their versatility. They can be as
conservative or as speculative as one's
investment strategy dictates. Some of the
benefits of Options are as under:
 High leverage as by investing small amount
of capital (in the form of premium), one can
take exposure in the underlying asset of
much greater value.
 Pre-known maximum Risk for an option buyer
 Large profit potential & limited risk for Option
 buyer3
 One can protect his equity portfolio from a
decline in the market by way of buying a
protective put wherein one buys puts against
an existing stock position this option position
can supply the insurance needed to overcome
the uncertainty of the marketplace. Hence, by
paying a relatively small premium (compared
to the market value of the stock), an investor
knows that no matter how far the stock
drops, it can be sold at the strike price of the
Put anytime until the Put expires. E.g. An
investor holding 1 share of Stock "A" at a
market price of Rs 3800 thinks that the stock
is over-valued and therefore decides to buy a
Put option" at a strike price of Rs. 3800/- by
paying a premium of Rs 200/- If the market
price of Stock "A" comes down to Rs 3000/,
he can still sell it at Rs 3800/- by exercising
his put option. Thus by paying a premium of
Rs. 200, he insured his position in the
underlying stock.
18. How can I use options ?
If you anticipate a certain directional movement
in the price of a stock, the right to buy or sell that
stock at a predetermined price, for a specific
duration of time can offer an attractive
investment opportunity. The decision as to what
type of option to buy is dependent on whether
your outlook for the respective security is positive
(bullish) or negative (bearish). If your outlook is
positive, buying a call option creates the
opportunity to share in the upside potential of a
stock without having to risk more than a fraction
of its market value (premium paid). Conversely, if
you anticipate downward movement, buying a
put option will enable you to protect against
downside risk without limiting profit potential.
Purchasing options offer you the ability to
position yourself according to your market
expectations in a manner such that you can both
profit and protect hedge) with limited risk.
 
19. Once I have bought an option & paid the
premium for it, how does it get settled ?
Option is a contract, which has a market value
like any other tradable commodity. Once an
option is bought there are following alternatives
that an option holder has: You can sell an option
of the same series as the one you had bought &
close out /square off your position in that option
at any time on or before its expiration date. You
can exercise the option on the expiration day in
case of European Option or; on or before the
expiration day in case of an American option. In
case the option is "Out of Money" at the time of
expiry, one will not exercise his option, not being
profitable and therefore, it will lapse or expire
worthless.
 
20. What are the risks for an Option buyer ?
The risk/ loss of an option buyer is limited to the
premium that he has paid.
 
21. What are the risks for an Option writer ?
The risk of an Options Writer is unlimited whereas
his gains are limited to the Premiums earned.
When an uncovered call is exercised for physical
delivery, the call writer will have to purchase the
underlying asset and his loss will be the excess of
the purchase price over the exercise price of the
call reduced by the premium received for writing
the call.
The writer of a put option bears a risk of loss if
the value of the underlying asset declines below
the exercise price. The writer of a put bears the
risk of a decline in the price of the underlying
asset potentially to zero. When put option holder
exercises his option in the falling market,the put
writer is bound to purchase the underlying at
strike price, even if the underlying is otherwise
available in the spot at lower price.
 
22. How can an option writer take care of
his risk ?
Option writing is a specialized job, which is
suitable only for the knowledgeable investor who
understands the risks, has the financial capacity
and has sufficient liquid assets to meet applicable
margin requirements. The risk of being an option
writer may be reduced by the purchase of other
options on the same underlying asset and thereby
assuming a spread position or by acquiring other
types of hedging positions in the options/ futures
and other correlated markets.
 
23. Who can write options in Indian
Derivatives market ?
In the Indian Derivatives market, SEBI has not
created any particular category of options writers.
Any market participant can write options.
However, the margin requirements are stringent
for options writers.
 
24. What are Stock Index Options ?
The Stock Index Options are options where the
underlying asset is a Stock Index e.g. Options on
"Sensex". Index Options were first introduced by
Chicago Board of Options Exchange (CBOE) in
1983 on its Index "S&P 100". As opposed to
options on Individual stocks, index options give
an investor the right to buy or sell the value of an
index which represents group of stocks.
 
25. What are the uses of Index Options ?
Index options enable investors to gain exposure
to a broad market, with one trading decision and
frequently with one transaction. To obtain the
same evel of diversification using individual
stocks or individual equity options, numerous
decisions and trades would be necessary. Since,
broad exposure can be gained with one trade,
transaction cost is also reduced by using Index
Options. As a percentage of the underlying value,
premiums of Index options are usually lower than
those of equity options as equity options are
more volatile than the Index.
 
26. Who would use index options ?
Index Options are effective enough to appeal to a
broad spectrum of users, from conservative
investors to more aggressive stock market
traders. Individual investors might wish to
capitalize on market opinions (bullish, bearish or
neutral) by acting on their views of the broad
market or one of its many sectors. The more
sophisticated market professionals might find the
variety of index option contracts excellent tools
for enhancing market timing decisions and
adjusting asset mixes for asset allocation. To a
market professional, managing the risk
associated with large equity positions may mean
using index options to either reduce their risk or
to increase market exposure.
 
27. What are Options on individual stocks ?
Options contracts where the underlying asset is
an equity stock, are termed as Options on stocks.
They are mostly American style options cash
settled or settled by physical delivery. Prices are
normally quoted in terms of the premium per
share, although each contract is invariably for a
larger number of shares, e.g. 100.
 
28. Which are the stocks on which options
are available ?
Stocks are selected on the basis of they satisfying
various eligibility and selection criteria. The
various stocks, available for trading on the
Derivatives Segment of the exchange, can be
viewed at the List Of Products Section.
 
29. What is the market lot size of different
stock option contracts ?
The market lots for the stocks available for
trading on the Derivatives Segment of the
exchange can be viewed at the Contract
Specifications Section.
 
30. How will introduction of options in
specific stocks benefit an investor ?
Options can offer an investor the flexibility one
needs for countless investment situations. An
investor can create hedging position or an
entirely speculative one, through various
strategies that reflect his tolerance for risk.
Investors of equity stock options will enjoy more
leverage than their counterparts who invest in the
underlying stock market itself in form of greater
exposure by paying a small amount as premium.
Investors can also use options in specific stocks
to hedge their holding positions in the underlying
(i.e. long in the stock itself), by buying a
Protective Put. Thus they will insure their portfolio
of equity stocks by paying premium. ESOPs
(Employees" stock options) have become a
popular compensation tool with more and more
companies offering the same to their employees.
ESOPs are subject to lock in periods, which could
reduce capital gains in falling markets -
Derivatives can help arrest that loss
 
 
WEEKLY OPTIONS
1. What are Weekly Stock and Index Options
?
Presently, the Stock and Index Options are
offered for near, middle and far month contract
series. In response to a demand from market
participants for shorter maturity options, BSE has
decided to offer Weekly Options series (normally
Monday to Friday) in addition to the existing
Monthly Options series. Initially contracts for 1
week and 2 weeks duration will be launched and
thereafter, every week a fresh contract will be
launched with a 2 weeks maturity. Hence
normally, an investor will have, on any Monday, a
choice of either a 1 week Option or 2 weeks
Option.
Exchange Traded Options based on a Stock or
Index with shorter maturity of One or Two weeks
are known as Weekly Options.
 
2. How many Weekly Options will be
available for trading ?
One week and Two week Options will be available
for the market participants for trading.
 
3. How are Weekly Options different from
Monthly Options ?
Weekly Options differ mainly in terms of maturity
period. Currently Monthly Options have maturity
of 1 month, 2 months or 3 months. As 1 month
options expire,another options series get
generated. In case of Weekly Options, the
maturity will be either 1 week or 2 weeks.
Monthly Options Series will expire on last
Thursday of every month. In case of Weekly
Options, series will expire on Friday of every
week.For Example if the Weekly Options are
launched on September 13, 2004,
commencement and expiration schedule will be
as follows:

Week Start Date Option Expiry Date

1 04/08/2008 2 week Option 15/08/2008
2 11/08/2008 2 week Option 22/08/2008
3 27/9/2004 2 week Option 8/10/2004
4 4/10/2004 2 week Option 15/10/2004
In the above table the weekly series which are
generated on 1st week i.e. on 04/08/2008 will be
expiring on 15/08/2008 and similarly the weekly
series will be generated for 2nd, 3rd and 4th
week. Thus effectively, on any Monday, say, on
11/08/2008, an investor will have a choice to
invest in either a 1 week Option expiring on
15/08/2008 (residual time of the 2 week option
opened on 04/08/2008) or the 2 week Option
expiring on 22/08/2008, that has been opened on
11/08/2008.
In case of weekly series generated on 3rd week
i.e. 18/08/2008 the weekly option will be expiring
on 29/08/2008, If the expiry day i.e. 29/08/2008
fall on a trading Holiday, then the expiry previous
trading day i.e. 28/08/2008 is the last Thursday
of the month (i.e. on the same day, the Monthly
series is expiring) then the relevant Weekly series
expiring on that day will not be generated.
 
4. What will happen if expiry day is a
Trading Holiday ?
If the expiry day of Weekly Options fall on a
trading Holiday , then the expiry (as per SEBI
guidelines) will be on the previous trading day.
If that previous trading day is the last Thursday
of the month (i.e. on the same day, the Monthly
series is expiring) then the relevant Weekly series
expiring on that day will not be generated.
 
5. What are the Similarities between
Monthly and Weekly Options?
The parameters viz. Underlying, Contract
Multiplier, Tick size, Price Quotation, Trading
Hours, Strike price Intervals of the Weekly
Options will remain exactly the same as that of
Monthly Options.
 
6. What are the benefits of Weekly Option
Contracts?
 Weekly Options will command lower premium
due to shorter maturity. Thus the Weekly
 Options will cost less than the Monthly
Options.
 For similar capital outlay as Monthly Options,
participants can take larger positions.
 Weekly Options will provide opportunity for
Arbitrage between :
 "One week to maturity"options and "two
week to maturity" options.
 Weekly Options and Monthly Options.
 On account of low cost, the liquidity will
improve, as more participants would come in.
 Weekly Options would lead to better price
discovery and improvement in market depth.
 The market participants would be able to take
a short-term view in the underlying also.
 Weekly Options would provide market
participants short term insurance for their
short-term portfolio.This would result in
better price discovery and improvement in
market efficiency.
7. What are the Risk Management measures
taken at the Exchange level ?
Since the introduction of Weekly Options is just
the addition of new series and not a new product
as such, the Risk Containment measures adopted
for the Weekly Options would be similar to those
applied for Monthly Options.
 
8. Can we compare the premium quoted for
Weekly Options with that of Monthly Options
?
The theoretical cost of an at-the-money call
option with one month to expiry where the
underlying price is Rs. 320 with annual volatility
of 50% is Rs.19 and that of an at-the-money call
option with 5 days to expiry is Rs.7.50.
 
 
LONG DATED OPTIONS
1. What are Long dated Options on
"SENSEX®"?
BSE has introduced 'Long Dated Options on
"SENSEX@ "whereby the members can trade in
Sensex (normal lot of 15 only and not 'mini'
Sensex) Options contracts with an expiry upto 3
years. These long-term options provide the
holder the right to purchase, in the case of a call,
or sell, in the case of a put, a specified number of
quantity at a pre-determined price up to the
expiration date of the option, which can be three
years in the future.  
 
2. What are Equity Long dated Options?
Equity Long dated Options are currently not
available in BSE however these are long-dated
put and call options on stock.  
 
3. When do Long dated Options expire?
As with normal options, the expiration date is the
last Thursday of the month if it's a holiday then
expiry will be a day before Thursday.  
 
4. What are the trading hours for Long
Dated Options?
As with regular equity options, the trading hours
for LONG DATED OPTIONS are from 9:55 a.m. to
3:30 p.m. IST.  
 
5. What are the features of Long dated
Options?
Longer Tenure
Investor can use long-term calls to diversify their
portfolios. Long term put provide investors with
means to hedge current stock holdings.
Longer term Options offer a good alternative to a
longer-term trader to gain exposure to a
prolonged period in a given security without
having to roll several short-term contracts.  
 
6. What option series will be available for
Long dated Options?
The options series available for the Sensex
(normal lot of 15) Options contracts will be as
below:
a.The 3 existing serial month contracts (i.e.
Near middle and Far month) would continue.
b.The following additional 3 quarterly months of
the cycle Mar/Jun/Sep/Dec would be
available.
c. Further, 5 additional semi-annual months of
the cycle Jun/Dec would be available, so that
at any point in time there would be options
contract with up to 3 years tenure available.
These series will be available for trading from 29-
February -2008.
To illustrate, from the March series onwards i.e.
from February 29, 2008 onwards, the users will
get to trade the following Futures and Options
contracts on the normal Sensex market lot of 15 :
1. Three monthly Futures contracts viz.
March, April and May 2008
2. Three monthly Options contracts viz.
March, April and May 2008
3. Three quarterly Options contracts viz.
June 2008, September 2008, December 2008
4. Five semi-annual Options contracts viz.
June 2009, December 2009, June 2010,
December 2010 and June 2011
 
CHHOTA(MINI) "SENSEX"
1. What is Chhota(mini) "SENSEX@"?
It is mini Futures & Options contracts on the SENSEX@
in Market Lot of FIVE in addition to the existing contracts
available on the SENSEX@ in a larger market lot.  
 
2. What are the benefits of Chhota(mini)
"SENSEX"?
The mini contract will offer the following benefits:
 mini futures and options have market lot of
FIVE, hence lower capital outlay (for margin)
and lower trading costs
 smaller contract value allows for more precise
 hedging and flexible trading
 more arbitrage opportunities available
 easy access by the retail investor to the
SENSEX@ that constitutes 30 leading
companies of diverse industries covering 12
broad sectors of the Indian economy thus
providing macro view of the economy to
investors.
For further information visit
http://www.bseindia.com/about/minisenx.asp
 
 
USD SENSEX® FUTURE
What is USD SENSEX@ Future?
The Chicago-based U.S. Futures Exchange (USFE)
has joined hands with BSE for the launch of a US
Dollar-denominated Sensex futures contract that
will trade 23 hours a day from April 4, 2008.
USFE's SENSEX contract will allow eligible U.S.
investors to directly participate in India 's equity
markets for the first time, without requiring
American Depository Receipt (ADR) authorization.
The contract will have a notional value of around
USD 40,000 and a tick size of $ 10. The detailed
information on the contract is available at
http://www.usfe.com/products-ei-sensex.html
 For further information please contact us on -
                                Ameya Bhagwat - Tel: 22723887 (D);
22721233/34 (Extn: 8419)
                                Suhel Plasar - Tel: 22721233/34
(Extn: 8436)
                                Runjhun Lall - Tel: 22721233/34
(Extn: 8844)
                                Shivam Gupta - Tel: 22721233/34
(Extn: 8346)
Email: derivativesinfo@bseindia.com
 
 
CALCULATIONS
1. What are the profits and losses in case of a futures
position ?
The profits and losses would depend upon the difference
between the price at which the position is opened and the p
at which it is closed. Let us take some examples.

Example 1
 Position - Long - Buy June Sensex Futures @ 15000
 Payoff -
o Profit - if the futures price goes up
 o Loss - if the futures price goes down
 Calculation - The profit or loss would be equal to fi
times the difference in the two rates.
o If June Sensex Futures is sold @ 15500 there wou
a profit of 500 points which is equal to Rs.
(500*15).
o However if the June Sensex However if the June Se
Futures is sold @ 14700 , there would be a loss o
points which is equal to Rs. 4500 (300*15).

Example 2
 Position - Short - Sell June Sensex Futures @ 15500
 Payoff -
o Profit - if the futures price goes down
o Loss - if the futures price goes up
 Calculation - The profit or loss would be equal to fi
times the difference in the two rates.
o If June Sensex Futures is bought @ 15900 there w
be a loss of 400 points which is equal to Rs.
(400*15).
o However if the June Sensex Futures is bought @ 15
there would be a profit of 300 points which is equ
Rs. (300*15).
2. What happens to the profit or loss due to daily
settlement ?
In case the position is not closed the same day, the daily
settlement would alter the cash flows depending on the
settlement price fixed by the exchange every day. However
net total of all the flows every day would always be equal t
profit or loss calculated above. Profit or loss would only dep
upon the opening and closing price of the position, irrespec
of how the rates have moved in the intervening days.
Let's take the illustration given in example 1 where a long
position is opened at 15000 and closed at 15800 resulting i
profit of 800 points or Rs. 12000. Let's assume that the pos
was closed on the fifth day from the day it was taken. Let's
assume three different series of closing settlement prices o
these days and look at the resultant cash flows.

Example 3
Daily closing settlement price

  Case 1 Case 2 Case 3

Day 1 14900 14800 14500
Day 2 15350 15300 15100
Day 3 15280 15400 14950
Day 4 14950 14700 15200
Position closed 15800 15800 15800
 

Case 1 Settlement Calculation

 Price
Position
15000    
opened
Day 1   14900 14900-15000
Day 2   15350 15350-14900
Day 3   15280 15280 -15350
14950 -
Day 4   14950
15280
Position 15800 -
15800  
closed 14950
Net Profit/
     
Loss
 

Settlement
Case2 Calculation
Price
Position
15000    
opened
14800 -
Day 1   14800
15000
Day 2   15300 15300-14800
Day 3   15400 15400-15300
14700 -
Day 4   14700
15400
Position
15800   15800-14700
closed
Net Profit/
     
Loss
 

Settlement
Case3 Calculation
Price
Position
15000    
opened
14500 -
Day 1   14500
15000
Day 2   15100 15100 -14500
Day 3   14950 14950 -15100
15200 -
Day 4   15200
14950
Position
15800   15800 -15200
closed
Net Profit/
     
Loss
 
In all the cases the net resultant is a profit of 800 points, w
is the difference between the closing and opening price,
irrespective of the daily settlement price and different MTM
flows.
 
3. How does the Initial Margin affect the above profit
loss ?
The initial margin is only a security provided by the client
through the clearing member to the exchange. It can be
withdrawn in full after the position is closed. Therefore it do
not affect the above calculation of profit or loss.
However there may be a funding cost / transaction cost in
providing the security. This cost must be added to your tota
transaction costs to arrive at the true picture. Other items
transaction costs would include brokerage, stamp duty etc.
 
4. What is a spread position ?
A calendar spread is created by taking simultaneously two
positions
1. A long position in a futures series expiring in
calendar month
2. A short position in the same futures as 1 above bu
a series expiring in any month otherthan the 1 above.
Examples of Calendar Spreads
1. Long June Sensex Futures - Short July Sensex Futu
2. Short July Sensex Futures - Long August Se
Futures
A spread position must be closed by reversing both the legs
simultaneously. The reversal of 1 above would be a sale of
Sensex Futures while simultaneously buying the July Sense
Futures.
 
5. How are spread rates calculated ? Please illustrate
with an example.
The profit or loss in case of spreads depends only upon the
difference between the rates for the two different calendar
months. The real position is only of the differential -
irrespective of the two rates.
Let's take an example.
Example 4 - assuming the futures are being traded at the follow
rates

  June July August

  Bid Ask Bid Ask Bid Ask
Rate 16200 16250 17000 17100 17500 17550
The spread calculations are as follows

Spread Calculation Rate

June - July 17000 - 16200 800
July -August 17500 - 17000 500
June - August 17500 - 16200 1300
 
6. How do we calculate spreads in case of two way
quotations ?
In case the prices are quoted as bid and offer, the spreads
would also have a two way quotation. While calculating use
thumb rule that the spread rate calculated must have the
maximum spread possible from the two given rates.
Example 5 - Lets assume the futures are being traded
the following rates

  June July August

  Bid Ask Bid Ask Bid Ask
Rate 16200 16250 17000 17100 17500 17550
The spreads would be calculated as follows.

Spread Calculation Rate

June - July 17000 -16250 & 17100- 16200 750
July - August 17500 -17100 & 17590- 17000 400
June - August 17500 -16250 & 17590-16200 1250
Another thumb rule to check the correctness of calculation
that the bid offer difference of the spread must be equal to
sum of the bid-offer differences of the two futures contract
example the bid-offer difference for June-August spread is
points which is equal to the sum of the bid-offer difference
June Futures 50 points and August Futures 90 points.
 
7. Please give a simple illustration to explain the
mechanics of spread trading ?
To illustrate lets assume that the market is in Contango i.e
futures price is higher than the cash underlying price and th
futures price of far month is higher than the futures price o
near month.

  June July August

Rates 15500 16200 17000
The spread calculations are as follows

Spread Calculation Rate

June - July 16200 -15500 700
July - August 17000 -16200 800
June - August 17000 -15500 1500
 
Example 6
 Position -
o Receiving the spread – Buy near month futures +
far month futures
o Paying the spread – Sell near month futures +
far month futures
 Payoff -
o Profit - Spread received > spread paid
o Loss - Spread received< spread paid
 June- July spread is paid at 700 points . If June
 spread can be reversed at higher than 700 points it w
result in profit. Assuming that the spread is reversed a
points a profit of 100 points or Rs1500 would result.

Open Spread Sell June Buy July

Pay 700 15500 16200
       
Close   Buy June Sell July
Receive 800 15500 16300
Profit 100 0 100
Please note that the spread profit depends only upon the
differential received or paid, irrespective of the futures rate
the above example let's take three cases where reversal is
at 900 points but with substantially different levels for June
July.
 
Case 1 -17000 and 17900
 

Open Spread Sell June Buy July

Pay 700 15500 16200
       
Close   Buy June Sell July
Receive 900 16550 17450
Profit 200 1050 1250
 
Case 2 - 16550 and 17450  
 

Open Spread Sell June Buy July

Pay 80 4600 4680
       
Close   Buy June Sell July
Receive 900 16550 17450
Profit 200 1050 1250
Case 3 - 16000 and 16900  
 

Open Spread Sell June Buy July

Pay 700 15500 16200
       
Close   Buy June Sell July
Receive 900 16000 16900
Profit 200 500 700
 
You would notice that the profit is always 200 points
irrespective of the rates as the spread received is constant
900 points.