EXECUTIVE SUMMARY

In the global capital markets of today, derivatives occupy an integral part of the economy, and are virtually driving the world markets with the introduction of derivatives trading in the form of futures and options, the Indian capital market too is witnessing a qualitative change. While option trading is not new in the country, the growth in option trading has been accompanied by a tremendous interest among academics and practitioners in the valuing of option contracts. Financial derivatives are financial instruments whose prices are derived from the prices of other financial instruments. Option is one of the components in financial derivatives. The other components are Forwards, Futures, and Swaps. Derivatives being a very vast area ,the study is limited to section of derivatives, stock option. In option itself the study is concentrated only in option pricing using the Black- Scholes model. Already established pricing strategies in option pricing has been identified and were applied on the data collected from the companies like Reliance Industries, Tata steel, SAIL, HINDALCO and Ranbaxy Lab. Strike price was selected ramdomly. The market was very volatile during the period of the study. The annualized volatility is considered in the present analysis. The risk free rate of return is assumed to be constant for an year. The time period here is taken to be one month.The following strategy is used for the analytical study of the option pricing.

Black Scholes option pricing :- This model is used to calculate the value of a European call option . It can be mathematically expressed.

For the purpose of the study five different companies have been selected. The companies are Reliance Industries Tata Steel SAIL HINDALCO Ranbaxy Lab

The main objective of this study is to calculate the value of a European call option. For the purpose of the study I took Price of the underlying stock Option strike price Risk free interest rate Current time until expiration Volatility This study covers only the options market. It takes into consideration only the call option in the market at different strike prices. The companys shares which are considered in the market analysis are limited to those S&P CNX Nifty Index.

Chapter -1

INTRODUCTION
Securities market in India The market for long term securities like bonds, equity stocks and preferred stock is divided into primary and secondary market. The primary market deals with the new issues of securities. Outstanding securities are traded in the secondary market, which is commonly known as stock market. Well regulated and active stock market promotes capital information. Growth of the primary market depends upon the secondary market. The health of the economy is reflected by the growth of the stock market. Derivative A Derivative instrument broadly is a financial contract, whose pay off structure is determined by the value of an underlying commodity, security, interest rate, share price index, exchange rate, oil price etc. A derivative instrument derives its value from the underlying variable. A derivative instrument by itself does not constitute ownership. It is instead, a promise to convey ownership. Option

Option can be defined as a derivative contract which gives the holder a right, but no obligation, to buy or sell a specified quantity of the underlying asset on a future date at the pre determined price. The option price can be subdivided into intrinsic value and time value. For call option the intrinsic value is the excess of the stock price over the option strike price if the option is in the money or zero if the option is at the money or out of the money. Time value is the excess of the option price over the intrinsic value. It is time value that posses problem when estimating fair, or therotical, option prices.

ABOUT OPTION PRICING IN NSE

The researcher problem, selected for the purpose of dissertation titles OPTION PRICING IN NSE at GEOJIT FINANCIAL SERVICES LTD gives in depth knowledge about the equity option , current system of trading in India and valuation of option. Today only few investors are aware about the equity option in India. Investors feel that the equity option is purely a speculation. Investors are not aware of the valuation models that are currently available in the market and the formalities for the trading in equity option in the stock market. This work helps the investors for their future trading in equity option. Importance of the study Recently the increase of trading derivatives market particularly in the segment of equity option shows the importance of the study in option market. This study helps the investors for the better trading in equity option
5

market, and shows how to calculate the value of the call option. Very few investors know the Black & Scholes model of valuation of call. It is one the most complicated and most practical finance formulas in the world.

OBJECTIVES OF THE STUDY

To calculate the value of a call option To compare the actual value of the call option to its theoritial value To interpret the various reasons resulting to the variation

SCOPE OF THE STUDY

The study is limited to five selected industries. Reliance Industries Tata Steel SAIL HINDALCO

Ranbaxy Lab

RESEARCH METHODOLOGY
The research methodology adopted is to study the data available from secondary sources. The study is conducted at Geojit Financial Services Ltd. The details are collected from various sites and journals.

Type of study
The study conducted is basically to calculate the value of a European call option

Data collection
Almost all the data used in the study were secondary in nature.

Sources of data
The study is conducted at Geojit Financial Services. The sources of data include profile and annual reports of companies selected. Other sources of data are various web sites, periodicals and newspapers.

Technique used
The Black- Scholes model with its variants is probably the most commonly used option pricing model. This is despite its shortcomings, in

particular its inability to allow for exercise prior to expiry. One reason for its popularity is that it allows for an analytical solution.

The Black- Scholes model can be expressed as follows

Limitations of the study

The analysis is based on the information available in the cites and journals. Thus, the analysis suffers from serious inherent limitation. The time duration for this project being so limited that detailed study is not possible. This is just a snap study know about the equity option in India Data taken for this study is based on the real price of the share There was ambiguity in data collected from various sources. The secondary nature of the data has been a constraint for the study.
8

The research could confine only to industries.

five options in different

Chapter 2 INDUSTRY PROFILE

INDIAN CAPITAL MARKET AN OVERVIEW Indian stock market is one of the oldest markets in Asia. Its history dates back to nearly 200 years ago. The earliest record of security dealing in India is merger and obscure. The East India Company was the dominant institution in those days and business in its loan securities used to be transacted towards close of the 18th century. By 1830s business on corporate stock and shares in bank and cotton presses took place boarder in Bombay. Though the trading list was broader in 1839, there were only half a dozen brokers recognized by banks and merchants during 1840 and 1850 witnessed. The 1850s witnessed a rapid development commercial enterprise and brokerage business attracted many men into the field and by 1860 the number of brokers increased into 60.In 1860-61 the American civil war broke out and cotton supply from U.S to Europe was stopped. This share of thus the share mania in India began. The number of brokers increased about 200 to 250.However,at the end of the
9

American civil war in1865, disastrous slumps began (for example, bank of Bombay share which had touched Rs 2850 could only be sold Rs 87). At the end of the American civil war the brokers who thrived out of civil war in 1874 found a place in a street (now appropriately called as Dalal street) where they would conveniently assemble and transact business. In 1887, they formally established in Bombay, The Native Share and Stock Brokers Association (which is attractively known as The Stock Exchange). In 1895,the Stock Exchange acquired a premise in the same street and it was inaugurated in 1899. Thus, the stock exchange in Bombay was consolidated. STOCK EXCHANGE Stock Exchange means any body of individuals whether incorporated or not, consolidated for the purpose of assisting, regulating and controlling the business of buying, selling and dealing in securities. It is a market where stocks, shares and other securities are bought and sold and also to provide avenue for disposal of securities, when owner feel like. It is an essential component of the economy and indispensable for the proper functioning of corporate enterprise. The business is done using a screen based trading technologies through dually authorized members f the exchange. The stock exchange is opened to anyone big or small with money to invest or securities to sell. In modern capitalized economy almost all commodities even in small are produced on a large scale and large scale production implies large amount of capital. The joint stock company or corporate form of organization is ideally suited to large amount of capital from all those who have surplus fund. When a joint company issues stocks and bonds, surplus fund employed profitably in either of them according to convince and temperament. The stock exchange enable
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the investing to shift from one business to another without any difficulty. An investor, who put his savings in a company by buying its securities, cannot get the amount back from the company directly. The only way the capital invested in stocks and shares of a joint stock company may be realized by its owner is through the sale of those stock and shares to others. The stock changes hands, but it circulates with the market only.

NATIONAL STOCK EXCHANGE

The Organisation The National Stock Exchange of India Limited has genesis in the report of the High Powered Study Group on Establishment of New Stock Exchanges, which recommended promotion of a National Stock Exchange by financial institutions (FIs) to provide access to investors from all across the country on an equal footing. Based on the recommendations, NSE was promoted by leading Financial Institutions at the behest of the Government of India and was incorporated in November 1992 as a tax-paying company unlike all other stock exchanges in the country. On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital Market (Equities) segment commenced operations in November 1994 and operations in Derivatives segment commenced in June 2000. National Securities Clearing Corporation Ltd. (NSCCL)

11

The National Securities Clearing Corporation Ltd. (NSCCL), a wholly owned subsidiary of NSE, was incorporated in August 1995. It was set up to bring and sustain confidence in clearing and settlement of securities; to promote and maintain, short and consistent settlement cycles; to provide counter-party risk guarantee, and to operate a tight risk containment system. NSCCL commenced clearing operations in April 1996.

NSCCL carries out the clearing and settlement of the trades executed in the Equities and Derivatives segments and operates Subsidiary General Ledger (SGL) for settlement of trades in government securities. It assumes the counter-party risk of each member and guarantees financial settlement. It also undertakes settlement of transactions on other stock exchanges like, the Over the Counter Exchange of India. NSCCL has successfully brought about an up-gradation of the clearing and settlement procedures and has brought Indian financial markets in line with international markets National Commodity Clearing Limited In order to harness its expertise in the area of Clearing and Settlement activities and in keeping pace with the growing commodity markets in India and to provide a special thrust and focus on the Clearing & Settlement needs of the commodity markets, a subsidiary company, namely, National Commodity Clearing Limited (NCCL) has been incorporated jointly between NSE and NCDEX. Presently, the Company provides IT and process support in respect of clearing & settlement needs of NCDEX. National Securities Depository Ltd. (NSDL)

12

In order to solve the myriad problems associated with trading in physical securities, NSE joined hands with the Industrial Development Bank of India (IDBI) and the Unit Trust of India (UTI) to promote dematerialisation of securities. Together they set up National Securities Depository Limited (NSDL), the first depository in India. NSDL commenced operations in November 1996 and has since established a national infrastructure of international standard to handle trading and settlement in dematerialised form and thus completely eliminated the risks to investors associated with fake/bad/stolen paper. NSE Infotech Services Limited Information Technology has been the backbone of conceptualization, formation, running and the success of National Stock Exchange of India Limited (NSE). NSE has been at the forefront in spearheading technological changes in the securities market. It was important to give a special thrust and focus on Information Technology to retain the primacy in the market. Towards this, a wholly owned subsidiary, namely, NSE Infotech Services Limited (NSETECH) has been incorporated to cater to the needs of NSE and all its group companies, exclusively. India Index Services & Products Ltd. (IISL) India Index Services and Products Limited (IISL), a joint venture between NSE and CRISIL Ltd. (formerly the Credit Rating Information Services of India Limited), was set up in May 1998 to provide a variety of indices and index related services and products for the Indian capital markets. It has a consulting and licensing agreement with Standard and

13

Poor's (S&P), the world's leading provider of investible equity indices, for co-branding equity indices. IISL provides a broad range of services, products and professional index services. It maintains over 80 equity indices comprising broad-based benchmark indices, sectoral indices and customised indices. Many investment and risk management products based on IISL indices have been developed in the recent past, within India and abroad. These include index based derivatives traded on NSE and Singapore Exchange (SIMEX) and a number of index funds. NSE.IT Ltd. NSE.IT, a 100% subsidiary of National Stock Exchange of India Limited (NSE), is the information technology arm of the largest stock exchange of the country. A leading edge technology user, NSE houses stateof-the-art infrastructure and skills. NSE.IT possesses the wealth of expertise acquired in the last six years by running the trading and clearing infrastructure of largest stock exchange of the country. NSE.IT is uniquely positioned to provide products, services and solutions for the securities industry. There has been a long felt need for top-of-the-line products, services and solutions in the area of trading, broker front-end and backoffice, clearing and settlement, web-based trading, risk management, treasury management, asset liability management, banking, insurance etc. NSE.IT's expertise in these areas is the primary focus. The company also plans to provide consultancy and implementation services in the areas of Data Warehousing, Business Continuity Plans, Stratus Mainframe Facility Management, Site Maintenance and Backups, Real Time Market Analysis & Financial News over NSE-Net, etc. NSE.IT is an Export Oriented Unit with STP and plans to go global for various IT services in due course. In the near
14

future the company plans to release new products for Broker Back-office Operations and enhance NeatXS / Neat iXS to support Straight Through Processing on the net.

DotEx International Limited The data and info-vending products of NSE are provided through a separate company DotEx International Ltd., a 100% subsidiary of NSE, which is a professional set-up dedicated solely for this purpose. DotEx data products may be classified under the following broad categories:

On-line streaming data feed (Level 1 and Level 2 data) Intra-day Snapshot data feed End of day data Historical data

Derivatives in the Indian context India perhaps was once the worlds largest futures trading market till early when commodities from the least consumed lentils to the most valued commodity. The prospects of derivatives trading are unlikely in the near future. Primarily conditions of exchange and lack of proper infrastructure. Moreover the existing participants to upgrade practices to be online with other developed exchanges worldwide. Currently the forward trading
15

marked lacks professionalism and follow old practices. The trading pattern needs up gradation like other exchanges viz. equities and bonds. Further more there is a lack of depth in the market.

COMPANY PROFILE

ABOUT GEOJIT FINANCIAL SERVICES LTD

Mr. C.J. George and Mr. Ranajit Kanjilal founded Geojit as a partnership firm in the year 1987. In 1993, Mr. Ranajit Kanjilal retired from the firm and Geojit became a proprietary concern of Mr. C .J. George. In 1994, it became a Public Limited Company by the name Geojit Securities Ltd. The Kerala State Industrial Development Corporation Ltd. (KSIDC), in 1995, became a co-promoter of Geojit by acquiring 24% stake in the company, the only instance in India of a government entity participating in the equity of a stock broking company. Geojit listed at The Stock Exchange, Mumbai (BSE) in the year 2000. In 2003, the Company was renamed as Geojit Financial Services Ltd. (GFSL). The board of the company consists of professional directors; including a Kerala government nominee with 2/3rd of the board members being Independent Directors. With effect from July 2005, the company is also listed at The National Stock Exchange (NSE). Geojit is a charter member of the Financial Planning Standards Board of India. Geojit Financial Services Ltd. is one of the largest DP brokers in the country.

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VISION
The vision of the company is to be a leading financial and commodities markets intermediary for individual and institutional clients from India and Overseas and continually strive to raise our product and service standards by intelligent application of technology and processes.

MILESTONES

The company crossed the following milestones to reach its present position as a leading retail broking house in India. In 1986, Geojit became a member of the Cochin Stock Exchange. In 1994, The Kerala State Industrial Development Corporation (KSIDC), an arm of the Government of Kerala, becomes a co-promoter of the company by acquiring 24% equity stake in Geojit Financial Services Ltd., based on the evaluation report of Ernst & Young. This is the only venture in India where a state owned development institution is participating in the equity of a stock broking company. Geojit becomes a corporate broking house. In 1995, Geojit comes out with a small Initial Public Offer (IPO) of Rs.9.5 million, which was oversubscribed by 15 times. Geojit's issued and subscribed equity capital increased to Rs.30 million and KSIDC's equity stake comes down to 17%. Geojit becomes a member of the National Stock Exchange (NSE) and installs its first trading terminal in Cochin, Kerala.

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In 1996, the company launches Portfolio Management Services after obtaining required registration (Portfolio Management) from (SEBI). In 1997, Geojit became a Depository Participant under National Securities Depository Limited (NSDL) and begins providing Depository Services through its branches. In 1999, Geojit became a member of The Stock Exchange, Mumbai (BSE) and activates Bombay Online Terminals (BOLT) in different branches. The customer base of Geojit crosses the 50,000 mark. In 2000, Geojit became the first broking firm in the country to offer online trading facility. The then SEBI Chairman, Mr. D.R.Mehta inaugurates the facility on 1st February, 2000. It commenced Derivative Trading after obtaining registration as a Clearing and Trading Member in NSE. It also established the first Bank Gateway in the country for Internet Trading. In 2001, Geojit's customer base crosses 100,000. It became India's first DP to launch depository transactions through Internet. Geojit established Joint Ventures in the UAE for serving NRI clients. The company issued bonus shares in the ratio of 1:1. In 2002, Geojit ties up with MetLife for the marketing and distribution of insurance products across the country. The company became the first online brokerage house to launch integrated internet trading system for both cash and derivatives segments. Sheikh Sultan Bin Saud Al Oassemi, a member of the ruling family of Sharjah, UAE, joins the Board of Directors of Geojit. In 2003, Geojit Commodities Limited, a wholly owned subsidiary of Geojit, became member of National Multi-Commodity Exchange of India Ltd., National Commodity & Derivatives Exchange Ltd., Multi Commodity Exchange and launches Commodity Futures Trading in rubber, pepper, gold, wheat and rice. Geojit Commodities Limited launches Online Futures
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Trading in multiple commodities namely, agri-commodities, precious metals like gold and silver, other metals like steel, aluminium, etc. and energy futures namely, crude oil and furnace oil. Geojit raises more than Rs.100 million through issue of preferential shares.

In 2005, Barjeel Geojit Securities LLC became a member of Dubai Gold Commodity Exchange. Customer base of Geojit crosses 250,000. Geojit's reach spreads through a network of more than 300 branches. The company issues bonus shares in the ratio of 1:1. Geojit Credits, a subsidiary of Geojit Financial Services Ltd. registers with Reserve Bank of India as a Non-Banking Financial Company (NBFC). The company gets listed on National Stock Exchange of India Limited. The company implements Employees Stock Option Scheme. The company opens a first of its kind - all women's branch in Cochin. In 2006, Geojit re-launched Internet trading on Reuters TIB Mercury Platform. On March 13, 2007 the formation of Geojit BNP Paribas Financial Services Ltd., was announced in Mumbai and Paris. Through a preferential allotment, BNP Paribas had taken 27% stake in Geojit, which will eventually increase to 34.35%. With this final step, the French banking major has become the largest shareholder in Geojit Financial Services Limited. BNP Paribas has one of the largest international banking networks with significant presence in Asia and the United States. With presence in more than 85 countries the bank has a headcount of more than 1,38,000.

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BOARD OF DIRECTORS

Mr. A. P. Kurian Mr. C. J. George Mr P.H.Kurian Mr. Mahesh Vyas Mr. Rakesh Jhunjhunwala Mr. Ramanathan Bupathy Mr. Punnoose George

Non - Executive & Independent Chairman Managing Director & Chief Promoter Non - Executive Director Non - Executive & Independent Director Non - Executive Director Non - Executive & Independent Director Non - Executive Director

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MANAGEMENT

Mr. C. J. George Mr. Satish Menon Mr. A. Balakrishnan Mr. K. Venkitesh Mr. Stefan Groening Mr. Jean-Christophe Mr. Binoy .V.Samuel

Managing Director Director (Operations) Chief Technology Officer National Head - Distribution Director (Planning and Control) Director (Marketing) Chief Financial Officer Chief of Human Resources

Mrs. Jaya Jacob Alexander -

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AWARDS AND RANKINGS (1)Ranked 501 among the best companies in India
-Survey by Business India in 2006 (2)Ranked 444 among the ET 500 companies in India -Survey by Economic Times in 2006 (3)The India. Online Trading Platform of UTI Bank provided by Geojit won prize instituted by the Indian by the Banking Association of

ORGANIZATION STRUCTURE Companies: I.Geojit Financial Services Ltd

The parent company, Geojit Financial Services Ltd,is on the verge of being renamed as Geojit BNP Paribas Financial Services Ltd,providing services for Equities and Derivatives Trading, Internet

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Trading, Depository Services, Equity Research, Portfolio Management Services, Mutual Funds, Bonds, IPOs, Life insurance, General Insurance.The company has 384 branches in India and 5 in UAE.

II.Geojit Commodities Ltd

Geojit Commodities is a fully owned subsidiary of Geojit Financial Services Ltd,which started its operation in March 2003.Almost 300 terminals of the company are dedicated to commodity trading,that contribute 13% of the consolidated income generated by the company.The company has forayed into futures trading in Rubber, Pepper, Gold, Rice, Cardamom and Coffee.

III.Geojit Technologies Pvt.Ltd

Geojit Technologies,wholly owned subsidiary of Geojit Commodities Ltd,engages in developing state-of-the-art technologies for the financial sector.The company has a fleet of software engineers who are well versed in various technology platforms.Apart from providing hardware,software and networking solutions to the financial IT sector the company is providing back office solutions to its competitors as well.The company also has a domain catering to shipping logistics.It has a branch in the Dubai Free Trade Zone.

IV.Geojit Credits Pvt Ltd

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Geojit Creits is a subsidiary company of Geojit Financial Services registered with the Reserve Bank of India as a Non deposit taking Non Banking Finance company(NBFC-ND).The company grants loans against security of shares and warehouse receipts.

BUSINESS ACTIVITIES
(1).Depository Services As a depository participant under NSDL,Geojit offers depository services to its clients.It provides the facility for the safe custody of dematerialized securities.Account Maintainance Charges constitute the income of this statement. (2).Stock Broking Acting as an intermediary to facilitate buying and selling of shares in the National Stock Exchange and the Bombay Stock Exchange.These services are offered for a commission called Broking Charges which is the main revenue of the company. (3).Commodity Futures Acting as an intermediary to facilitate buting and seling of commodities in NMCEIL,MCX,and NCDEX.These services are offered for a commission called Broking charges. (4).Distribution of Financial Products

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Geojit

distributes

different

financial

products

like

Mutual

Funds,IPOs,Bonds and Insurance(Life and General).The commission received for selling these products constitutes the revenue.

(5).Portfolio Management Services(PMS) A licensed PMS service provider from SEBI,the company undertakes fund management for resident and non-resident clients.This is a service fee-based activity. (6).Software Development and Sales The experienced software professionals of Geojit Technologies with complete software development lifecycle experience have enabled the company to provide state-of-the-art facilities like digitally signed contract notes,holding statements,24/7 customer support,online research reports etc.Even though the primary domain knowledge of the company is in the financial sector,it also provides solutions to shipping and logistics management.The company is now engaged in the process of developing training platforms to facilitate online trading.Selling software solutions to exchanges,other brokerages and shipping companies generates the revenue of the company. (6).Loan against Shares and Warehouse Receipts Geojit Credits provides loans at a reasonable interest on pledge of securities and warehouse receipts.

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COMPANY MEMBERSHIPS
Geojit is a member of:-National Stock Exchange of India Ltd(NSE) -Bombay Stock Exchange Ltd(BSE) -Multi-Commodity Exchange of India(MCX) -National Commodity and Drivatives Exchange Ltd(NCDEX) -National Multi-Commodity Exchange of India Ltd(NMCE) -National Securities Depository Ltd(NSDL) -Central Depository Services Ltd (CSDL) -India Pepper and Spice Trade Association(IPSTA) -Singapore Commodity Exchange(SICOM) -Dubai Gold Commodity Exchange(DGCX) Geojit Financial Services Ltd is s SEBI registered Portfolio Manager(Reg No:INP000000316). Geojit Credits Pvt.Ltd is a registered Non-Banking Finance Company(NBFC) with RBI.

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DEPARTMENTS IN CORPORATE OFFICE Geojit Financial Services Ltd

(1).Depository (2).Client Registration (3).Operations (4).Barjeel Operations (5).Online Operations (6).Customer Care Center (7).Portfolio Management Services (8).Risk and Settlement (9).Systems and MIS (10).Distribution (11).Legal and Cpompliance (12).Finance (13).Human Resources (14).Administration (15).Corporate Communications (16).Secretariat Geojit Commodities Ltd. (1).Operations (2).Research
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(3).Risk (4).Finance (5).Administration (6).Distribution

Geojit Credits Ltd. (1).Operations (2).Finance Geojit Technologies Ltd. (1).Software development-Broking Business (2).Software development-Shipping Logistics (3).Software development-Overseas (4).Online Trading Products and Services

PRODUCTS

Equity F&O Margin Trading Funding Scheme Loan Against Shares Loan for Commodity Trading Depository Commodity Portfolio Management Services
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Chapter 3
THEORETICAL OVERVIEW

History of the stock market of India The origin of the stock market in India can be traded back to the later half of 19th century. After the American civil war(1860-61) due to the share mania of the public, the number of brokers dealing organized and informal association in Mumbai named the Native Stock and Share Brokers Association in 1875. Increased activity in trade and commerce during the First World War and Second World War resulted in an increase in the stock rating. Stock exchanges were established in different centers like Chennai, Delhi, Nagpur, Kanpur, Hyderbad and Banglore. The growth of stock exchanges suffered a set back after the end of the world war. World wide depression affected the stock exchanges also. Most of the stock exchanges had a speculative nature of working without technical strength. Securities and Contract Regulation Act,1956 gave powers to the central government to regulate the stock exchanges in Mumbai, Calcutta, Ahmedabad, Delhi, Hyderbad and Indore

29

were recognized by SCR ACT. Banglore Stock Exchange was recognized only in 1963. Till recent past, floor trading took place in all the stock exchanges in the floor trading system, the trade takes place through open outcry system during the official trading hours. Trading posts are assigned for different securities where buy and sell activities of securities took place. The system needs a face-to face contract and restricts volume. The speed of new information reflected affected the prices rather slowly. The deals also were not transparent and the system favored the brokers rather than the investors. The setting up of NSE and OCTCIE with the screen based trading facility resulted in more and more stock exchanges turning towards the computer based trading. The BSE introduced the screen based trading system in 1995, which is known as BOLT(Bombay Online Trading System) Madras Stock Exchange introduced an automated network trading system(MNATRA) on Oct 7th 1996. Apart from BSE, Vadodara, Delhi, Pune, Banglore, Calcutta and Ahmedabad exchanges also introduced screen based trading later on.

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Functions of the stock exchange: Maintain active trading Shares are traded on the stock exchanges, enabling the investors to buy and sell securities. The prices may vary transaction to transaction. A continuous trading practice increases the liquidity or marketability of the shares traded on the stock exchange. Fixation of price Price is determined by the transaction that flow from the investors demand and the suppliers preferences. Usually traded prices are made known to the public. This helps the investors to make better decisions. Ensures safe and air dealing The rules, regulations and by laws of the stock exchange provides a measure of safety to the investors to let an air deal. Aids in financing industry A continuous market for shares provides a favorable climate for raising capital. The negotiability and transferability of the securities helps the companies to raise long term funds. When it is easy to trade the securities, the investors are willing to subscribe to the initial public offerings. This stimulates the capital formation.
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Dissemination of information Stock exchanges provide information through their various publications. They publish the share prices traded on the daily basis along with the volume traded. Directory of the corporate information is useful for the investors assessment regarding the functioning of the stock exchanges. Performance inducers The prices of the stocks reflect the performance of the traded companies. This makes the corporate more concerned with its public image and tries to maintain good performance. Self-Regulating organization The stock exchanges monitor the integrity of the companies listed in the exchange and the clients. Continuous internal audit safeguards the investor against unfair trade practices. It also settles the disputes between members, brokers and investors. Regulatory frameworks A comprehensive legal framework was provided by the Securities Contract Regulation Act, 1956 and the SEBI Act,1992. A three tier regulatory structure comprising the ministry of finance, SEBI and the governing boards of the stock exchanges regulates the functioning of the stock exchanges.
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Ministry of finance The stock exchanges division of the ministry of finance has powers related to the application of the provision of the SCR ACT and the licensing of the dealers on the other area. According to the SEBI Act, the ministry of finance has the appellate and supervisory powers over the SEBI. It has power to grant recognition to the stock exchanges and regulation of their operations. Ministry of finance has the power to approve the appointments of the executive chiefs and nomination of the stock exchanges. It has the responsibility of prevailing undesirable speculation.

SEBI (Securities Exchange Board of India) SEBI even though established in the year 1988, received statutory powers only on 30 Jan 1992. Under the SEBI Act, a wide variety of powers is vested in the hands of SEBI. SEBI has the power to regulate the business of stock exchanges, other security markets and mutual funds. Regulation of market intermediaries is also carried out by SEBI. It has the responsibility to prohibit the fraudulent unfair trade practices and insider dealings. Take over of companies is also monitored by SEBI. SEBI plays an important role in prompting the healthy growth of the capital market and in protecting the investors.

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The governing board The governing board of the stock exchange consists of elected member directors, government nominees and public representatives. Rules, by laws and regulations of the stock exchange provide substantial powers to the Executive Director for maintaining efficient and smooth day functioning of the stock exchanges. The governing board has the responsibility to maintain an orderly and well- regulated market. The governing board of the stock exchange consists of thirteen members of which Six members are elected by the members of the stock exchange. Central government nominates not more than three members. The board nominates three public representatives. SEBI nominates not more than three members. The stock exchange appoints one Executive Director. One third of the members should retire at the annual general meeting. The retired members can offer themselves for election if he/she is not elected for two consecutive years. If a member has been serving the governing board for two consecutive years then he should refrain from offering himself for the next consecutive years.

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Changes in the security market The securities market in India witnessed several policy initiatives during the year 2001-02, which further refined the market micro-structure, modernized operations and broadened investment choices for investors. The irregularities in the securities transactions in the last quarter of the previous financial year hastened the introduction and implementation of serial reforms. While a joint parliamentary committee was constituted to look into the irregularities and manipulations in the transaction s relating to securities, decisions were taken to complete the process of dematerialization and corporation of stock exchanges to implement the decisions to separate ownership, management and stock exchanges and to effect legislative changes for investor protection, and to enhance the effectiveness of SEBI, the capital market regulator. Rolling settlement on T+5 bases was introduced in respect of most active 251 securities from July2, 2002 and in respect of balance securities from December31, 2001. Rolling settlement on T+3 bases commenced for all listed securities from April1, 2002. All deferral products such as carry forward were banned from July2,2002 and trading I options on individual securities commenced in June 2001 and trading in options on individual securities commenced in July 2001-02. The year 2001-02 has also been most
35

eventful from debt markets incorporation for government securities, a negotiated dealing system to facilitate transparent electronic bidding in auctions and secondary market transactions on real time basis and dematerialization of instruments.

What is a Derivative? A Derivative instrument broadly is a financial contract, whose pay off structure is determined by the value of an underlying commodity, security, interest rate, share price index, exchange rate, oil price etc. A derivative instrument derives its value from the underlying variable. A derivative instrument by itself does not constitute ownership. It is instead, a promise to convey ownership. Origin and development of derivatives The word derivative originated from mathematics and refers to a variable, which has been derived from another variable. For example a measure of weight in pound could be derived from a measure of weight; similarly derivative is a financial product, which has been derived from a market for another product. Without the underlying product and market it would have no independent existence. The explosion of growth in the derivative markets coincided with the collapse of Bertton Woods fixed exchange rate regime and suspension of the dollars convertibility into gold. Exchange rates became much more volatile
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and because interest rates are affected by the exchange rates, interest rates also become volatile. A means of managing risk was required. This need eventually resulted in the creation of the financial derivative industry.

Derivatives in the Indian context India perhaps was once the worlds largest futures trading market till early when commodities from the least consumed lentils to the most valued commodity. The prospects of derivatives trading are unlikely in the near future. Primarily conditions of exchange and lack of proper infrastructure. Moreover the existing participants to upgrade practices to be online with other developed exchanges worldwide. Currently the forward trading marked lacks professionalism and follow old practices. The trading pattern needs up gradation like other exchanges viz. equities and bonds. Further more there is a lack of depth in the market. Trading volumes in the permitted commodities currently is very low to attract the futures by even domestic standard and therefore. Setting up national commodities derivatives exchange at this stage would be too premature. The underlying cash or ready market is almost non-existent in this context.

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Types of financial derivatives The important financial derivatives are the following: 1. Forwards 2. Futures 3. Options 4. Swaps

CONCEPT OF OPTIONS In the world of investments, an option is a type of contract between two parties when one person grants the other person the right to buy a specific asset at a specific price within a specific time period. Alternatively, the contract may grant the other party the right to sell a specific asset at a specific price within a specific time period. The person who has the received the right and thus has a decision to make is known as the option buyer since he or she must pay for the right. The person who has sold the right to the buyer and thus must respond to other buyers decision is known as the option writer.

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Generally stock option are looked upon as a speculative vehicle as in any option there is a risk of loss to both contracting parties, a buyer who uses the option and a seller who makes good the option terms. The optional might realize there is no benefit for services performed under the option. The corporation might requires to forego a much larger cash sum during the option period that they wished to pay in cash compensation at option was granted. Yet the expectation of the market increase must be such that it out weights the expectation of loss and thus provides desirable speculation acceptable to both parties. It is desirable to the corporation as a means of obtaining valuable services for a minimum current cash outlay, and it is desirable to the optional as means of obtaining a large amount of income than could otherwise be on a straight cash payment basis. Options compared to common stock Options share many similarities with common stock: Both the option and stock are listed securities. Orders to buy and sell options are handled through the brokers in the same way as order to buy and sell stocks. Listed option orders are executed on the trading floors of national SEC-regulated exchanges where all trading is conducted in an open, competitive auction market. Like stocks, options trade with the buyers making bids and sellers making offers. In the stock, the bids and offers are for shares of stock. In the options, the bids and offers are the right to buy or sell 100 shares of the underlying stocks at a given price per share for given period of time.
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 Option investors, like stock investors, have the ability to follow price movements, trading volume and other pertinent information day by day or even minute by minute, the buyer or seller of an option can quickly learn the price at which his order has been executed. Despite being quite similar, there are also some important differences between options and common stocks which should be noted. Unlike common stock, an option has a limited life. Common stock can be held indefinitely in the hope that its value may increase, while every option has an expiration date. If an option is not closed out or exercised prior to its expiration date. It ceases to exist as a financial instrument. For this reason, an option is considered a wasting asset. There are not a fixed number of options as there is with common buyer willing to pay a price to obtain certain rights and seller willing to grant stock, the number of outstaying options depends on the number if buyers and sellers interested in receiving and conferring the rights Unlike stocks have certificates evidencing their ownership, options are certificate less. Option positions are indicated on printed statement prepared by the buyers or sellers brokerage firm. Certificates less trading, an innovation of the option markets, sharply reduces paper work and delays. Finally while stock ownership provides the holder with a share of the company, certain voting rights to dividends option

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owners participate only in the potential benefit of the stocks price movement.

Option: Historical Perspective The concept of option is not a new one. In fact options have been in use for centuries. The idea of an option existed in ancient Greece and Rome. The Romans wrote on the cargoes that were transported by their ships. In the 17th century, there was an active options market in Holland. In fact, options were used in large measure in the tulip bulb mania of that century. However, in the absence of a mechanism to guarantee the performance of the contract, the refusal of many put options writers to take delivery of the tulip bulbs and pay the high prices of the bulbs they had originally agreed to led to bursting the bulb bubble during the winter of 1673, a number of speculators were wiped out in the process. Options were traded in the USA and UK during the 19th century but were mainly confirmed to the agricultural commodities. Earlier, they were declared in the UK in 1733 and remained so until 1860 when ACT declaring them illegal was repealed. They were again banned in the third decade of this century, albeit temporarily. In USA, options on equity stocks of the companies were available on the OTC market only, until April 1973. They were not stabilized an involved the intra-party risk.

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In India options on stocks of companies, though illegal have been traded for many years, in a limited form. As such this trading has been a very risky proportion to undertake. In spite of the long time that has elapsed since the inceptions of options, they were, until not every long ago, looked down upon as mere speculative tools and associated with corrupt practices. Things changed dramatically in the 1970,s when the options were transformed from relative obscurity to systematically traded asset which is an integral part of the financial portfolios. The year 1973 witnessed some major developments. Black and Scholes published a seminal paper explaining the basic principles of options pricing and hedging. On the same year, the Chicago Board of Options was created. It was first registered securities exchange dedicated to option trading. While trading in options existed for long, it experienced a gigantic growth with the creation of this exchange. The listing of options meant orderly and thicker markets for this kind of securities. An option trading is now undertaken widely in many countries besides the USA and UK. In fact, options have become an integral part of the large and developed financial markets. USES OF OPTION There are number of reasons for being either a writer or a buyer of option. The writer assures an uncertain amount of risk for a certain amount of money, where as the buyer assures an uncertain potential gain for a fixed cost. Such a situation can be less to number of reasons for using options.
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However, fundamental to either writing or buying an option is the promise that option is fairly valued in terms of the course, an additional source of profit or loss is introduced, and the writer or buyer of such contract may be subject to an additional handicap that will reduce his or her return the reasons for writing contracts are varied, but three of the most common are to cash additional income and a securities portfolio, the fact that option buyers are not as sophisticated as writers, and to hedge a long position. It is some time argued that option writing is a source of additional income for the portfolio of an investor with a large portfolio of securities. Such an approach assumes that the portfolio manager can guess the direction of specific stock prices closely rough to make this strategy worth while what cannot be overlooked is that the writer gives up certain rights when the option is written. For example, suppose a call option is written. In this case the writer would presumably cover the call by the giving up securities from his or her portfolio. Hence, the writer is giving up any appreciation beyond striking price plus option premium. A third reason for writing option is to edge a long term position in a stock portfolio manager is concerned that stock may decline, if the stock is sold he or she will have to pay a capital gains tax. Selling an option would involve a minimum risk of having the stock called away. There are a number of reasons for buying option: two of the common are leverage and charging the risk complication of a portfolio. The term leverage in connection with option indicates buyer being able to control more securities then could be done with realistic merging requirements. In other words, with the use of merging, the buyer of securities can buy more securities and hopefully make a greater profit then could be done by taking a long position, puts send calls
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can be used in much the same passion and perhaps provide higher return. Another reason of buying is to change the risk completion of a portfolio of securities. It should be noted that this benefits of option is available not only to buyers but also to writers. Therefore they permit portfolio managers to undertake as much or as little as he or she feels is appropriate at a point of time. They also give additional flexibility in setting the amount of risk the portfolio managers willing to accept with respect to a specific portfolio. Definition Option can be defined as a derivative contract which gives the holder a right, but no obligation, to buy or sell a specified quantity of the underlying asset on a future date at the pre determined price. Accordingly, an option contract consists the following. Two parties, option buyer and option sellerOption buyer also known as option holder enjoys the rights to purchase or sell the underlying as per the terms or the contract. However, it is not obligatory from his side that this right has to be executed. In other words, the buyer has absolute freedom to walk away from the contract if he feels that the terms of the contract are not in his favor. Option seller, also known as option writer is obligated to buy or sell as per the contract terms provided; the buyer comes forward to execute his rights. Underlying; the agreement is drawn on a specified quantity of an asset and this is known as underlying.

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Strike price: Both the parties have agreed to transact the business at a particular price and this will be recorded on the contract. This is called the strike price or the exercise price. An options is called the premium the potential loss for the holder of an option is limited to the initial premium paid for the contract. The writer on the other hand has unlimited. Expiry date: The contract will be valid up to certain point of the time as recorded on the document and this is called the expiry date. Option premium Option premium is the price that has to be paid by the option buyer to the seller to acquire the right to buy or sell. The buyer this is the cost of buying options where this is the income to option seller. Settlement price This is the price at which the exchange clears all outstanding positions on the settlement day (generally, the expiry day) and the price is arrived at on the basis of the spot value of the asset on the day.

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TYPES OF OPTION
Broadly options are classified into call option and put option CALL OPTION A call option gives it buyer the right to buy 100 shares of the underlying security at the strike price, anytime prior to the options expiration date. The writer of the option has the obligation to the sell shares. A call option gives the right, but no obligation to the contract buyer to purchase a specified quantity of the underlying asset subject to the contract terms such as price, exercise date etc. On the other side the seller of a call option is bound to honor the righter of the buyer as per the contract terms. Limited risk and unlimited profitability to the buyer A cash option is brought when the contract buyer is bullish about the underlying asset and expects that a profit be made by exercising his right at the strike price and selling asset at a higher price which is decided by the spot value of the value. If things are going as expected, the call buyer can make a handsome profit this could be termed as unlimited. On the other side,
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his loss is limited only up to the premium paid if the value of the asset remained stagnant or even lower. Limited profit and unlimited loss to the seller Unlike a call buyer, the writer of the call option is bearish on the underlying asset and the call is sold on the expectation that a profit could be made to the extent of the premium received. So long as he is right, the seller makes a profit but this is limited to the premium. On the other side, the call writer may be a big loser if the value of the asset increases. In such an occasion, he has to buy it from the market at higher prices to fulfill his obligation to sell to the call buyer and loss may be unlimited. Risk and return profile of option contracts If we look at the risk and return profile of the option contracts it is asymmetric unlike the futures contracts. Broadly speaking the option buyer has limited risk (the maximum loss is the premium paid to the option writer) and unlimited return potential. But the option writer has unlimited risk and limited return potential (the maximum gain is the premium received from the option buyer).

Payoff profile of Call Option Buyer

Strike price

profit zone
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profit/ loss

strike price + premium premium paid

asset price

loss zone Payoff profile of Call Option Seller Profit zone Premium received Strike price + premium

Strike price

Asset price Loss zone

Covered call If a call is written on asset on the backing of long position of the same asset in the cash market, it is known as covered call. Since, the call seller has bought the required quantity of the asset in the cash market: losses due to a price increase of the asset could be eliminated.
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Naked calls A naked call is one where the seller of the call option does not have position in the underlying asset.

PUT OPTION The opposite of a call option is a put option, which gives its holder the right to sell 100 shares of the underlying security at the strike price, anytime prior to the options expiration date. The writer of the option has the obligation to buy shares. Put options refers to a type of option contract which gives its buyer a right, but no obligation to sell a specified quantity of the underlying asset on a future date at the agreed price(strike price). On the other side, the seller of the contract is obligated to buy the asset from the contract buyer as per agreed terms. The buyer enjoys unlimited profit and limited loss in the case of put option too while the seller has unlimited loss and limited profit. In the case of put option, contract buyer is bearish on the asset expects that the price would fall and intents to make a profit by selling at a higher price and settling the same by purchasing at a lower rate on the settlement day. The extent to which the strike price is higher to the settlement price is his profit and this can be termed as unlimited. On the other side, the maximum loss that incur to the contract buyer is limited up to the premium paid in case his expectation proved wrong.
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As far as the seller of the put option is concerned, his profit is limited to the premium received while the loss may go up to any level, subject to the difference between the strike price and the settlement price on which he has to sell or settle the account. It is clear that the risk much higher in option writing than in option buying. Option buyer also enjoy higher leverage to their funds in the sense that big positions of buying and selling could be maintained by payment of a small premium which is just a fraction of the value of assets underlying. Intrinsic value The difference between strike price of a contract and the spot value of the underlying asset at any point of time is the intrinsic value. Based on this, option contracts are said to be in the money, at the money and out the money. Settlement in option contracts Each option contract carries an expiry date beyond which, the contract does not have any value and all contracts have to be settled on the settlement date that may be either the expiry data itself or any day prior to that. On the day of settlement , all open position positions which are in the money are compulsorily settled by the exchange at the settlement price which is the spot value of the asset in question on the asset the settlement day and subsequently, the profit is handed over to buyers. All contracts at the money or out the money on the settlement will be to expire as worthless. American option
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In the American model of the option, call or put contracts can settled on any day that falls between the date of expiry and entry date. European options In the European options, settlement on all opens position could be undertaken on the settlement day alone. However, buying positions could squared up or selling positions could be covered by opposite transactions on a daily basis. Salient features of options trading Market lot Options contracts are standardized products as far as minimum value, market lot, expiry date etc. are concerned recommended by SEBI in the lots are designed as to maintain a minimum stipulated amount. Hence option contracts on NIFTY are available in the lots of 200 units and its multiples while the sensex is being traded in 50s lots. As far as stocks options are concerned, market lot differs from scrip to scrip and this is decided so as to ensure the minimum value of Rs. 2 lakhs per contract. Expiry date At any date of time three varieties of option contracts are available when looked from the maturity angle, namely the near month, next month and far month contracts and the expiry dates are on the last Thursday of each
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month for example in, January contracts are near month contracts February and March are next month and far month contracts respectively Trading and settlement Final settlement of options contracts is on the last Thursday of each month and all open positions on the settlement date will be closed out by the exchanges at the settlement price if the contracts are in the money. Option contracts out of the money or at the money will be allowed to expire because they are worthless from the point of view of option buyers. Besides, final settlement of the contracts by the exchange concerned, buying or selling positions holders and writers could be traded on daily basis and positions could be closed out at any time by entering into an opposite transaction. For example, buying position in a type of contracts could be closed out by affecting a sell and vice versa and profit can be booked without waiting for the final settlement day. Thus options are giving profitable trading opportunities to the participant on a daily basis. Risk in option trading The holder of the options runs the risk of losing his/her entire investment in buying the option in a relatively short period of time. This risk storms from the fact that an option is in the nature of a wasting asset it becomes worthless when it expires. If the price of the underlying asset doesnt change in the desired direction before the option expires i.e. by such a magnitude as would be sufficient to cover the cost of the option, the investor may lose a substantial amount proportionate to his/her investment.
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A profit can be made by selling the option in secondary market at a price, if available, greater than that paid for buying it. However, what is sought to emphasize here is that shorter the time of expiration, the less likely that it would be possible. There may be other problems as well leading to break down of the system. The failure of INSAT-2D in October, 1997,for eg; led to the suspension of activities on NSE for a week. Trading terminologies One can enter into the option segment as a buyer or seller in any contract type like call or put and can walk away with profit. The main terminologies are: Long one is long in a stock when he is having a purchase position in it. Hence, buying positions in call or put options can be termed as long as positions. Short a short position occurs when trader have an obligation to deliver. In options too, the term short is used in the same sense and it can be defined as the selling positions in call or put options. Opening buy it refers to the purchase of an option contract which has the effect of creating a fresh purchase position or adding to the exciting long position or adding to the existing long positions of a trader. Purchase can be effected in either call positions or put options.

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Opening sell- it means a sale position in either the call or put options and it creates a fresh sell position or adding to ones existing short position. Close out it is a buying or selling transaction which closes an open position fully or partly. For eg: a purchase in an option contract can be offset by the sale of a contract having the same characteristics. Closing buy it refers to a purchase transaction which has the effect of closing out a short position partly or wholly. For eg; a call option seller can close his short position through the purchase of call option and this is similar to short covering in the equity segment. In order to cover short segment position in call having some special features such as underlying asset, strike price, exercise date etc. one should select a call option having the same characteristics. Note that all call options cannot be closed out by the put option or vice versa. Through both the options should be fundamentally the same, the premium on which they are bought and sold may be different since this is determined by the market forces. It gives an opportunity to the trader to make gains from buying and selling the option contracts. Closing sell it means a sale transaction which offset a long position either wholly or partly. For eg: the buyer of a put option or a call option can eliminate his long position by affecting a sale in the same type of contract and this is similar to the squaring up of long positions in the equity market. As stated earlier, a long position in call can be closed out by the sale of a call option only and the basic characteristics of both the contracts such as

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underlying asset, strike price, expiry date etc. should be perfectly matched to each other. Option class- it may be defined as all listed options of a particular type on an underlying asset. Option series- it consists of all the listed options contracts of a given class that have the same strike price and expiry date. Option interest- it refers to the total number of contracts outstanding an a particular asset at any time that are not yet off settled by counter transactions or settled through delivery or payment of cash. Time value- an option contract is priced partly on the basis of the number of days left for its expiry and this is called time value. The premium on an option contract is decided by the intrinsic value and the time value. If more days are left to the expiry date, the premium would be higher due to better time value. Valuation of options- the option premium or the price determinate comparatively on the floor the options exchange by the influx buy and sell orders. It is influenced by a number of factors some of which are listed below: Price of the underlying security Volatility Length of time to expiration

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 Interest rates Tax rules with regard to gains and loses from option trading Margin requirements in case of uncovered option writers Transaction cost

THE BLACK SCHOLES OPTION PRICING MODEL Introduction

The option price can be subdivided into intrinsic value and time value. For call option the intrinsic value is the excess of the stock price over the option strike price if the option is in the money or zero if the option is at the money or out of the money. For put options the intrinsic value is the strike price minus the stoke price or zero if the stoke price exceeds the strike price. Time value is the excess of the option price over the intrinsic value. It is time value that posses problem when estimating fair, or therotical, option prices. The Black- Scholes model with its variants is probably the most commonly used option pricing model. This is despite its shortcomings, in particular its inability to allow for exercise prior to expiry. One reason for its popularity is that it allows for an analytical solution; this means that there is a formula into which certain values are input and from which an option price

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is forthcoming. This formula, when programmed into a computer or calculator, can produce option prices within seconds. An intuitive for this model can be obtained by regarding it as equating the price (premium) with the expected profit from a naked option. Expected profit is used in the sense of possible profit outcomes weighted by their probabilities of occurance.

The Black- Scholes model can be expressed as follows

Where

C is the call option price. S is the stock price N (d1) is the cumulative normal distribution function K is the strike price e is a constant whose value is 2.7182818 r is the risk free interest rate t is the time to expiry is the annualized standard deviation of stock returns (Volatility)

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The Black Scholes option pricing model is a statistical expectations based on normal distributions of returns. It is to be emphasized that this does not constitute a rigorous elucidations of the Black Scholes model. In particular, the Black Scholes model uses log normal rather than normal distributions. One reason for using log normal distributions is the need to avoid the possibility of negative stock prices; normal distributions allow for the possibility of any stock prices, including negative ones.

Assumptions of the Black and Scholes Model:

1) The stock pays no dividends during the option's life Most companies pay dividends to their share holders, so this might seem a serious limitation to the model considering the observation that higher dividend yields elicit lower call premiums. A common way of adjusting the model for this situation is to subtract the discounted value of a future dividend from the stock price. 2) European exercise terms are used European exercise terms dictate that the option can only be exercised on the expiration date. American exercise term allow the option to be exercised at any time during the life of the option, making american options more valuable due to their greater flexibility. This limitation is not a major concern because very few calls are ever exercised before the last few days of their life. This is true because when you exercise a call early, you forfeit the remaining time value on the call and collect the intrinsic value. Towards the end of the life of a call, the remaining time value is very small, but the intrinsic value is the same.

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3) Markets are efficient This assumption suggests that people cannot consistently predict the direction of the market or an individual stock. The market operates continuously with share prices following a continuous It process. To understand what a continuous It process is, you must first know that a Markov process is "one where the observation in time period t depends only on the preceding observation." An It process is simply a Markov process in continuous time. If you were to draw a continuous process you would do so without picking the pen up from the piece of paper. 4) No commissions are charged Usually market participants do have to pay a commission to buy or sell options. Even floor traders pay some kind of fee, but it is usually very small. The fees that Individual investor's pay is more substantial and can often distort the output of the model. 5) Interest rates remain constant and known The Black and Scholes model uses the risk-free rate to represent this constant and known rate. In reality there is no such thing as the risk-free rate, but the discount rate on U.S. Government Treasury Bills with 30 days left until maturity is usually used to represent it. During periods of rapidly changing interest rates, these 30 day rates are often subject to change, thereby violating one of the assumptions of the model. 6) Returns are log normally distributed This assumption suggests, returns on the underlying stock are normally distributed, which is reasonable for most assets that offer options.

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Using the Black and Scholes Model: An examination of the formula reveals that the inputs required to value an option are; current price of the stock(S), exercise price of that the premium (K), time remaining before expiration of the option (t), risk free rate of interest (r), standard deviation of the continuously compounded annual rate of return on the stock index and a normal probability tables. The first three of these are easily observable while an idea about the risk free rate of interest may be had taken the rate of return on a government security that has a maturity date closest to the continuously compounded annual rate of return on a stock may be obtained by using historical data on the stock returns. The module is derived under the assumption that the rates of return are identically disturbed over time. If this assumption were indeed to hold, then satisfactory estimates of variance can be made from there historical data. OPTION PRICING

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Price of option is commonly depending upon six factors. Unlike futures which derive there prices primarily from prices of the underlying, options pricing are far more complex. The affect of each of the below mentioned factors gives broad picture of option pricing keeping all other factors constant. Spot Prices:- more the spot price more is the payoff and it is favorable for the buyer. It is the other way round for the seller , more the spot price higher is the chances of his going into a loss. It is the reverse for put pricing. Strike Price:- A higher strike price would reduce the profit for the holder of the call option. Time to Expiration:-More the time to expiration more favorable is the option. This can only exist in case of American option as in case of European options the options contract matures only on the date of maturity. Volatility:- More the volatility, higher is the probability of the option generating higher returns to the buyer. The downside in both the cases of call and put is fixed but the gains can be unlimited. I f the price falls heavily in case of a call buyer then the maximum that he loses is the premium paid and nothing more than that. More so he/she can buy the same shares from the spot market at a lower price. Similar is the case of a put option buyer. Risk Free Rate of Interest In reality, the Risk- free rate and the stock market are inversely related. But theoretically speaking, when all other variables are fixed and interest rate increases this leads to a double effect. Increase in expected growth rate of stock price discounting factor increases making the price fall. In case of the put option both these factors increase and lead to decline in the put value. A higher expected growth leads to a higher price taking the buyer
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to the position of loss in the payoff chart. The discounting factor increases and the future value become lesser. In case of call option these effects work in the opposite direction. The first effect is positive at a higher value in the future the call option would be exercised and would give a profit. The second effect is negative as is that of discounting. The first effect is far more dominant than the second one, and the overall effect is favorable on the call option. Dividends:- When dividends are announced then the stock prices on exdividend are reduced. This is favorable for the put option and unfavorable for call option. In the money, at the money , or out of the money: If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in the money because the holder of this call has the right to buy the stock in the stock market. Likewise, if a put option has a strike price that is greater than the current market price of the underlying security, it is also said to be in the money because the holder of this put option has the right to sell the stock at price which is greater than the price he would receive selling the stock in the stock market. If the strike price equals the current market price, the option is said to be at the money. The amount by which an option, call or put, is in the money at any given time is called its intrinsic value. Thus an at the money or out the money has no intrinsic value;the time value is the total option premium. This does not mean however, these options can be obtained at no cost. Any amount by which an options total premium exceeds intrinsic value is called
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the time value portion of the premium. It is this time value of the premium that is affected by the fluctuations in volatility, interest rates, dividends and time. There are other factors that give option value and therefore affect the premium at which they are traded. Together, all of these factors determine time value. When an option buyer comes forward to execute his right to buy or sell, the obligations to honor this right upon the seller and a notice may be served for this purpose. The process of vesting on a sell is called assignment. In the money A contract is in the money when it is in favor of the buyer i.e. a profit is made by trading or exercising his rights.It depends on the difference between the strike price and the exercise price and differs for both put and call options. A call option is in the money when the strike price is less than the stock price.A put option is in the money when the strike price is greater than the stock price. At the money This day is called Expiration Friday, if the third Friday of the month is an exchange holiday. After the options expiration date the contract will cease to exist. At that point the owner of the option who does not exercise the contract has no right and the seller has no obligations previously conveyed by the contract. Out of the money An option contract is out of the money when the contract is not in favor of the buyer that is a profit could be generated by exercising the right or buy trading.

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A call option is out the money at times the strike price is higher than the spot price of the asset. In such circumstances, a profit could not be made from the contract. A put option is out of the money, the premium fetched by it may be lower compared to other times. A contract which may be out of the money at a point of time may turn to be in the money at another time and vice versa. Analysis of equity options trading in India There are two types of option in India- index option and individual securities. Both the types of equity options have been introduced in India recently by NSE and BSE. Index options Options on stock indices commenced on June 4, 2001 in the futures and option segment of the NSE and in BSE. Index options can be defined as contract on which underlying assets is stock index. These options contracts give us the right to buy or sell equity indices as per the contract terms such as strike price, expiry date etc. and the transaction will be settled in cash because the index cannot be handed over from person to person. The options are in European style. Currently, indexes are available on the S&P CNX Nifty of the NSE and on the Sensex of BSE. Contract specifications: Security descriptor for the S&P CNX Nifty options is: Market type: N Instrument type: Nifty Expiry date: date of contract expiry Option type: CE/PE
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Strike price: strike price for the contract Instrument type represents the Instrument i.e. option on index. Underlying symbol is the underlying index, S&P CNX Nifty Expiry date identifies the date of contract expiry Option type identifies whether the option is put or call CE- call European and PE- put European. The salient features of index option contract are : The contract size is 200 times the Underlying Index It is a European style option contract It has a maximum of three month trading, the near month, the next month and the far month. A new contract will be introduced on the next month trading day, following the expiry of the near month contract. The expiry date is the last Thursday of the expiry month or previous trading day if last Thursday of the expiry month is a holiday. The contract is cash settled. Strike price intervals The exchange provides a minimum of five strike prices for every option type during the trading month. At any time there are 2 contracts in the money , two out the money and one at the money. The strike price intervals are 10. The in the money strike price and the out of the money strike price are based on the at the money strike price interval.

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Options on Individual Securities NSE is the first to launch trading in Options on Individual Securities commenced from July 2, 2002. Options are in American style and cash settled are available on 41 securities stippled by SEBI. Options on individual securities have been introduced in NSE and BSE. The salient features of options on individual securities in NSE are: Options on individual securities in NSE will have a minimum of three month trading cycle. New contracts will be introduced on the trading day following the expiry of the near month contract. On the expiry of the near month contract, a new contract shall be introduced at new strike prices on the trading day following the expiry of the near month contract. The exchange provides a minimum of five strike prices for every option type during the trading month. The expiry date of options on individual securities is the last Thursday of the expiry month or previous trading day if last Thursday of the expiry month is a holiday.

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 The value of the contract options on individual securities shall not be less than Rs.200000, at the time of introduction. The permitted lot size for the option contracts on individual securities shall be multiples of 100 and fractions, if any, shall be rounded off to the next higher multiple of 100. The price steps in respect of all option contracts submitted to dealings in the exchange shall be Rs. 0.05 Base price of the option contracts on introduction of new contracts shall be the theoretical value of the options contract arrived at based on the Black & Scholes model of calculation of option premium. The base price of the contracts on subsequent trading days is the daily close price of the option contracts. Options on individual securities\are American style. Here the exercise type is automatic on the expiration day, and the exercise price is voluntarily prior to the expiration date of the option contract. Automatic exercise means that all in the money options contract. Options would be exercised by NSCCL on the expiration day of the contract. The buyer of such option need not give an exercised noticed such as. Voluntarily exercise means that the buyer of an in the money options is required to direct his broker to give exercise instructions to National Securities Clearing Corporation Ltd. Settlement of exercises of options on securities will be buy payment in cash and not by delivery of securities at least initially, in accordance to SEBI guidelines. The settlement day is T=3 days.

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Contract specifications: Security descriptor for options contract is: Market type: N Instrument type: OPTSTK Underlying: symbol of underlying security Expiry date: date of contract expiry Option type: CA/PA Strike price: strike price for the contract Instrument type represents the Instrument underlying security in the capial market segment. Expiry date identifies the date of contract expiry Option type identifies whether the option is put or call CA- call American and PA- put American.

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Chapter 4 REVIEW OF LITERATURE In this dissertation many international and national literatures related to this project has been reviewed. None of these books are giving clear information about this topic. Many magazines are focusing only on the international market i.e. US and Europe. There are no special books for the Indian context. In the context only very few studies relating to the topic is noticed. But these studies have their own limitations. No studies are covering the present system of equity option trading in India in detail. The book Futures and Options by N.D. Vohra and B.R. Bagri published by the Mc Graw Hill publication gives an idea about option and its strategies. The book Investment and Management by V.K.Bhalla published by 7th edition S.Chand publication is just mentioning the equity options, uses etc. and the study with different models.

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The report presented by Shah A & Thomas S(1997) published by oxford university press is giving the information of recent development of futures & options in Indian market. But it lacks the current system of option in India. In the context, this dissertation work has been taken a maximum effort to present the equity option, present system of option of valuation of option in details. The above mentioned books and journals are covering the different models of valuation of option in integral. Here in this study, only Black & Scholes model is taken into consideration. Chapter 4

ANALYSIS AND INTERPRETATION OF DATA

RELIANCE INDUSTRIES
Company Profile
The Reliance Group, founded by Dhirubhai H. Ambani (1932-2002), is India's largest private sector enterprise, with businesses in the energy and materials value chain. Group's annual revenues are in excess of US$ 34 billion. The flagship company, Reliance Industries Limited, is a Fortune Global 500 company and is the largest private sector company in India. Backward vertical integration has been the cornerstone of the evolution and growth of Reliance. Starting with textiles in the late seventies, Reliance pursued a strategy of backward vertical integration - in polyester, fibre intermediates, plastics, petrochemicals, petroleum refining and oil and
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gas exploration and production - to be fully integrated along the materials and energy value chain. Reliance enjoys global leadership in its businesses, being the largest polyester yarn and fibre producer in the world and among the top five to ten producers in the world in major petrochemical products. The Group exports products in excess of US$ 20 billion to 108 countries in the world. Major Group Companies are Reliance Industries Limited (including main subsidiaries Reliance Petroleum Limited and Reliance Retail Limited) and Reliance Industrial Infrastructure Limited.

Here S = 1351.30
K = 1050.00 r = 5.5% t = 1 month = .9284 e = 2.718 d 1 = . d1 = 1.0899 d2 = 0.8219 N(d1) = 0.8621 N(d2) = 0.7944
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ln (1351.30/1050.00) + {(.055+(.9284)2/2)) *0.083} 0.9284*0.2881

= 1351.30*0.8621-(1050/.9954)* 0.7944 = 334.38 ======

Actual value= 328.95 Difference = 5.4

Interpretation
From the above analysis it is seen that the theoretical value of call option obtained from the calculation is 334.38, but the actual value is 328.95. Hence there is a difference between the actual and theoretical value. Here the difference is 5.4.This difference might be due to mathematical errors. It can be also be due to minute deviation in the volatility values taken as annualized volatility is considered here. The difference hence is negligible. So we can see some difference from the actual value. Here the strike price is less than the market price of the underlying security. ie 1351.30 < 1050. Therefore the call option is in the money. Hence the price of an in the money call option is 334.38.

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TATA STEEL Company Profile

Backed by 100 glorious years of experience in steel making, Tata Steel is the worlds 6th largest steel company with an existing annual crude steel production capacity of 30 Million Tonnes Per Annum (MTPA). Established in 1907, it is the first integrated steel plant in Asia and is now the world`s second most geographically diversified steel producer and a Fortune 500 Company. Tata Steel has a balanced global presence in over 50 developed European and fast growing Asian markets, with manufacturing units in 26 countries. It was the vision of the founder; Jamsetji Nusserwanji Tata., that on 27th February, 1908, the first stake was driven into the soil of Sakchi. His

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vision helped Tata Steel overcome several periods of adversity and strive to improve against all odds. Tata Steels vision is to be the global steel industry benchmark for Value Creation and Corporate Citizenship.

Here S = 224.95 K = 150.00 r = 5.5% t = 1 month = 1.1621 e = 2.7182 d1 = (224.95/150) +{(0.055+(1.1621)2/2))*.083)} 1.1621*0.2881 d1 = 1.3913 d2 = 1.05 N(d1) = 0. 9178 N(d2) = 8545 C = 224.95*0.9178-(150*0.9954)*0.8545
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= 78.87 ===== Actual value = 76.15 Difference = 2.72

Interpretation
From the above analysis it is seen that the theoretical value of call option obtained from the calculation is 78.87, but the actual value is 76.15. Hence there is a difference between the actual and theoretical value. Here the difference is 2.72.This difference might be due to mathematical errors. It can be also be due to minute deviation in the volatility values taken as annualized volatility is considered here. The difference hence is negligible. So we can see some difference from the actual value. Here the strike price is less than the market price of the underlying security. ie 224.95 < 150. Therefore the call option is in the money. Hence the price of an in the money call option is 78.87.

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SAIL Company Profile

Steel Authority of India Limited (SAIL) is the leading steel-making company in India. It is a fully integrated iron and steel maker, producing both basic and special steels for domestic construction, engineering, power, railway, automotive and defence industries and for sale in export markets. Ranked amongst the top ten public sector companies in India in terms of turnover, SAIL manufactures and sells a broad range of steel products, including hot and cold rolled sheets and coils, galvanised sheets, electrical sheets, structurals, railway products, plates, bars and rods, stainless steel and other alloy steels. SAIL produces iron and steel at five integrated plants and three special steel plants, located principally in the eastern and central regions of India and situated close to domestic sources of raw materials,
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including the Company's iron ore, limestone and dolomite mines. The company has the distinction of being Indias largest producer of iron ore and of having the countrys second largest mines network. This gives SAIL a competitive edge in terms of captive availability of iron ore, limestone, and dolomite which are inputs for steel making. SAIL's wide range of long and flat steel products are much in demand in the domestic as well as the international market. This vital responsibility is carried out by SAIL's own Central Marketing Organisation (CMO) and the International Trade Division. CMO encompasses a wide network of 34 branch offices and 54 stockyards located in major cities and towns throughout India. With technical and managerial expertise and know-how in steel making gained over four decades, SAIL's Consultancy Division (SAILCON) at New Delhi offers services and consultancy to clients world-wide. SAIL has a well-equipped Research and Development Centre for Iron and Steel (RDCIS) at Ranchi which helps to produce quality steel and develop new technologies for the steel industry. Besides, SAIL has its own in-house Centre for Engineering and Technology (CET), Management Training Institute (MTI) and Safety Organisation at Ranchi.

Here S = 85.55
K = 70 r = 5.5% t = 1 month = 1.2167 e = 2.718

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d1 = (85.55/70) +{(0.055+(1.2167)2/2)*.083} 1.2167*0.2881 d1 = 0.7599 d2 = 0.4087 N(d1) = 0.7764 N(d2) = 0.6568 C = 85.55*0.7764-(70*0.9954)*0.6568 = 20.53 ===== Actual value = 19.60 Difference = 0.93

Interpretation
From the above analysis it is seen that the theoretical value of call option obtained from the calculation is 20.53, but the actual value is 19.60. Hence there is a difference between the actual and theoretical value. Here the difference is 0.93.This difference might be due to mathematical errors. It can be also be due to minute deviation in the volatility values taken as annualized volatility is considered here. The difference hence is negligible. So we can see some difference from the actual value. Here the strike price is less than the market price of the underlying security. ie 85.55 < 70. Therefore the call option is in the money. Hence the price of an in the money call option is 20.53.

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HINDALCO Company Profile

Hindalco Industries Limited, the metals flagship company of the Aditya Birla Group, is an industry leader in aluminium and copper. A metals powerhouse with a consolidated turnover in excess of US$ 14 billion, Hindalco is the world's largest aluminium rolling company and one of the biggest producers of primary aluminium in Asia. Its Copper smelter is the world's largest custom smelter at a single location. Established in 1958, Hindalco commissioned its aluminium facility at Renukoot in Eastern U.P. in 1962. Later acquisitions and mergers, with Indal, Birla Copper and the Nifty and Mt.Gordon copper mines in Australia, strengthened the company's position in value-added alumina, aluminium and
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copper products, with vertical integration through access to captive copper concentrates. In 2007, the acquisition of Novelis Inc. a world leader in aluminium rolling and can recycling, marked a significant milestone in the history of the aluminium industry in India. With Novelis under its fold Hindalco ranks among the global top five aluminium majors, as an integrated producer with lowcost alumina and aluminium facilities combined with high-end rolling capabilities and a global footprint in 12 countries outside India.

Here S = 54.10 K = 50.0 r = 5.5% t = 1 month = 0.9343 e = 2.718 d1 = ln (54.10/50) +{(0.055+(0.9626)2/2))*.083} 0.9626*0.2881 d1 =0.2999 d2 = 0.03016 N(d1) = 0.6174 N(d2) = 0.5126

C = 54.10*0.6174-{(50*0.9954)*0.5126}
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= 7.82
=====

Actual value= 4.90 Difference = 2.98

Interpretation
From the above analysis it is seen that the theoretical value of call option obtained from the calculation is 7.82, but the actual value is 4.90. Hence there is a difference between the actual and theoretical value. Here the difference is 2.98.This difference might be due to mathematical errors. It can be also be due to minute deviation in the volatility values taken as annualized volatility is considered here. The difference hence is negligible. So we can see some difference from the actual value. Here the strike price is less than the market price of the underlying security. ie 54.10 < 50. Therefore the call option is in the money. Hence the price of an in the money call option is 7.82.

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RANBAXY LAB Company Profile

Ranbaxy Laboratories Limited, India's largest pharmaceutical company, is an integrated, research based, international pharmaceutical company, producing a wide range of quality, affordable generic medicines, trusted by healthcare professionals and patients across geographies. Ranked 8th amongst the global generic pharma companies, Ranbaxy today has a presence in 23 of the top 25 pharma markets of the world. The Company has a global footprint in 49 countries, world-class manufacturing facilities in 11 countries and serves customers in over 125 countries. It was established in 1961.

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Earlier in June 2008, Ranbaxy entered into an alliance with one of the largest Japanese innovator companies, Daiichi Sankyo Company Ltd., to create an innovator and generic pharmaceutical powerhouse. The transformational deal will place Ranbaxy in a higher growth trajectory. The ranking of the combined entity will be catapulted to the No. 15th position in the global pharmaceutical space and it will emerge stronger in terms of its global reach and in its capabilities in drug development and manufacturing.

Here S = 217.15 K = 200 r = 5.5% t = 1 month = 0.7283 e = 2.718 d1 = ln (217.15/200) +{(0.055+(0. 7283)2/2*).083} 0. 7283 *0.2881 d1 = 0.5184 d2 = 0.3082 N(d1) = 0.6979 N(d2) = 0.6210

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C = 217.15*0.6979-{(200*0.9954)*0.6356} = 27.92 =====

Actual value = 33.00 Difference in value = 5.078

Interpretation
From the above analysis it is seen that the theoretical value of call option obtained from the calculation is 27.92, but the actual value is 33.00. Hence there is a difference between the actual and theoretical value. Here the difference is 5.078.This difference might be due to mathematical errors. It can be also be due to minute deviation in the volatility values taken as annualized volatility is considered here. The difference hence is negligible. So we can see some difference from the actual value. Here the strike price is less than the market price of the underlying security. ie 217.15 < 200. Therefore the call option is in the money. Hence the price of an in the money call option is 27.92.

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Chapter 5 FINDINGS

There is a difference between the actual value of option and the theoretical value of option calculated from Black- Scholes Model. The risk free interest rate, for instance the rate from a 90 day treasury bill is assumed to be constant. The rate can vary and such changes in interest rates make relatively small changes in the theoretical option price.

The mathematical value of volatility is considered to be 'the annualized standard deviation of a stocks daily price changes'. The present monthly volatility can vary from annualized volatility as there
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had been a wide fluctuation in the capital market at present. Changes in volatility also cause changes in the theoretical option prices.

Large differences, understand that the market is expecting a 'bigger' move in the underlying, for instance from some pending news Nifty options also suffer from 'cost-of-carry' bias, as future prices of Nifty options are usually less than Nifty spot prices plus interest element.

Dividend declaration can also cause minute amount of deviation in theoretical value from the actual value of options. Price volatility is the key to the growth of options; derivatives volatility here means two way price movements in an asset. The selection of strike price faces some difficulty. Here all the call option is in the money. ie the strike price of the call option is less than the market price of the underlying security. SUGGESTIONS

Minute deviations in the theoretical value calculated from the

Black- Scholes Model can be neglected and the theoretical values is accepted as the option value. To evade the cost of carry aspect of nifty options, the spot price term (S) can be replaced by the by the discounted value of future price (F.e-rt) in the Black-Scholes Formula

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CONCLUSION
The intended purpose of this dissertation is to provide a deep knowledge of valuation of option price at NSE. The study has shown that, there is a difference between the actual value of option and the theoretical value of option calculated from BlackScholes Model. The difference is found to be mainly due to change in volatility due to the wide fluctuation in the present market.the deviation can also de due to mathematical errors which is negligible. Option helps to understand the actual value of the shares and the difference between actual and the theoretical value can be further used to estimate whether an option is overpriced or underpriced. The pricing
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system enables the option trader to select a suitable option so that he can obtain its benefit including flexibility, leverage and limited risk for buyers employing this strategies, and contract performance under the system created by NSCCL rules, Option can be also used to hedge a stock position to acquire and sell stock at a purchase price more favorable than the current market price, or in the case of writing options to earn premium income. Despite their many benefits, options involve risk and are not suitable for everyone. An investors desire to utilize options should have well defined investment objectives suited to his particular financial situation and a plan for achieving these objectives. The successful use of options requires a willingness to learn what they are, how they work, and what risks are associated with particular options strategies.

BIBLIOGRAPHY References
Fundamentals of Futures and Option markets - John C. Hull Investment Analysis and Portfolio Management - Prasanna Chandra

Web sites

www.nseindia.com
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www.moneycontrol.com www.myiris.com

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