Preface

Most of financial derivatives trading activities began extensively during seventies as recently as 1973 with the introduction of futures trading in foreign exchange which was followed by the interest rate futures in 1975, stock index futures in 1982 and so on. Due to globalization and liberalization process initiated by the states all over the world, the international trade and financial activities have grown in multifold resulting into rising level of all types of risks for market participants such as market risk, interest rate risk, foreign exchange risk, inflation risk and price risk. Financial derivatives like options, futures, forwards and swaps have emerged in the financial markets to handle and emerged in the financial markets to handle and manage such risks. Options and futures trading in India commenced from June, 2000 on National Stock Exchange and Bombay Stock Exchange in stock index futures, stock futures, stock index option and stock option. It was a welcome step on the part of the government since it was important in the present environment. This was significant development in the history of Indian stock markets. A lot of trading in futures and options segment in India stock market was seen and the number of market participants increased phenomenal in a short period. As a result, awareness about the financial derivatives instruments and their application has increased among the investing people at large. On the other side of this development was that element of risk and volatility in the stock market has risen.

Key Features
This project is written with the objective that investor may get clear and logical way that why they should invest in selected stocks for option trading. This project gives investors knowledge about highly volatile stocks. Investors gain profit at lesser risk by investing in this stocks. It determines the strategy that will hedge the funds of investors in buying options.

OBJECTIVE OF RESEARCH
1.SEARCH FOR BEST COMPANIES FOR INVESTMENT IN BUYING OF OPTIONS IN INDIAN DERIVATIVE MARKET.

2. DETERMINING STRETEGY THAT WILL HEDGE THE FUNDS OF INVESTORS IN BUYING OPTIONS.

History
In the 1988s the process of liberalization and deregulation of the financial markets gain momentum when British & American leadership led, what could perhaps be considered as the world wide deregulatory movement. With the integration of the financial markets and free mobility of capital, risks also multiplied and risk diversification came to occupy the center stage. This logically led to the risk hedging mechanisms, first in the forex market, later in the other segments of financial service industry and these have come to be known generally as Derivatives. After emerging in USA, the derivatives business expanded rapidly and flourished in the European markets.

Introduction
Financial derivative is a financial instrument whose payoff is based on the price of an underlying asset, reference rate, or an index. The term derivatives is hardly thirty years old in the academic discipline of finance, though it does not necessarily mean that they are a modern invention. Since derivatives market have been in existence for as long, and by many accounts even longer than that for securities, it has been their growth in the past 30 years that has made them a significant segment of the financial markets. Today, the financial derivatives have become increasingly popular and most commonly used in the world of finance. This has grown with so phenomenal speed all over the world that now it is called as the derivatives revolution. In an estimate, the present annual trading volume of derivative markets has crossed US $ 30,000 billion, representing more than 100 times gross domestic product of India.

Definition
The Securities Contracts (Regulation) Act 1956 defines derivatives as under: Derivatives includes
1.

Security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security.

2. A contract which derives its value from the prices, or index of prices of underlying securities.

Types of derivatives;
Derivatives

Financials

Commodities

Basic

Complex

Forwards ,

Futures Options

Warrants & Convertibles

Swaps

Exotics (Non-standard)

Types as per availability

Commodity derivatives
The underlying instrument is a commodity which may be wheat, cotton, pepper, sugar, jute, turmeric, corn, crude oil, natural gas, gold, silver, copper and so on.

Financial derivatives
The underlying instrument may be treasury bills, stocks, bonds, foreign exchange, stock index, cost of living index, etc. Financial derivative is fairly standard and there are no quality issues whereas in commodity derivative, the quality may be the underlying matters.

Basic financial derivatives

A forward contract is a simple customized contract between two parties to buy or sell an asset at a certain time in the future for a certain price. Unlike future contracts, they are not traded on an exchange, rather traded in the over-the-counter market, usually between two financial institutions or between a financial institution and one of its clients.

Derivative contracts have several variations. The most common variants are following:
FORWARD: A forward contract is a customized contract between two entities,
where the settlement takes place on a specific date in the future at todays preagreed price.

FUTURES: A future contact is an agreement between two parties to buy or sell

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

OPTIONS: Options are of two types CALL: calls give the buyer the right but not the obligation to buy a given
quantity of the underlying assets, at a given future date.

PUT: Puts give the buyer right, but not the obligation to sell a given quantity of
assets at a given price on or before a g given date.

SWAPS: swaps are private agreements between two parties to exchange flows in
the future according to a prearranged formula. They can be regarded as portfolios of forward contracts.

HEDGING:
For limiting financial risk Hedging take two positions that will offset each other if prices change.

In regards to financial market hedging is done by investing funds in more than financial product in such a way that losses that may occur due to one investment will be covered by other.

(b) The Sample

The research requires comparison of fluctuation in share prices of all the companies in which derivative trading is allowed. Therefore data of all the companies are collected. Since few companies are recently listed with Stock exchange board of India, data of those companies are not available for whole year therefore they are excluded from the study.

(c)TOOLS
FOR DATA COLLECTION: The data require for the project are share
prices of last 52 weeks. Internet is used for the collection of data. Web site of national stock exchange keep record of share prices of all companies listed to Stock exchange Board of India. The data is collected from the web site of national stock exchange.

FOR DATA ANALYSIS: Standard deviation and coefficient of variation are

statistical tools used for the analysis of data.

Dispersion is the measure of the variation of the item

A.L bowley:
Dispersion is the degree of the scatter or variation of the variable about a central value.

Brooks and Dick:

Standard deviation is a statistical tool to measure dispersion in a series.

Definition: Standard deviation is a square root of arithmetic average of the

square of derivative measured from mean.

Standard deviation = [((x*X)-(X*X)/N]/N

Where, X= value of the item. N= Number of items.

Coefficient of variation: For purpose of relative measure of dispersion. We

calculate coefficient of variation.

Coefficient .of variation= standard deviation /X*

Where, X* =mean value of all items in a given series

BETA: The most important source of risk is the market risk because it cannot be
eliminated through diversification. The Modern Portfolio Theory, therefore, argues that the riskiness of a security should be measured by its vulnerability to market risk. If the market were to go down by 1%, would the security go down by 0.5%, by 1% or by 2%? This sensitivity of the security to the movement of the market is known as the beta coefficient of the security.

BETA= (nxy-x*y)/ (nx2-(x2))

Where, X= % change in Nifty Y=% change in particular stock

Steps in calculating standard deviation

1. Find the square of the values of various variables and total them. 2. Find square of total of all the values. Divide it by the number of items. 3. Subtract the above values from sum of square of variables and divide it by number of items. 4. Find square root of above calculation.

RESULTS
NAME OF THE COMPANY BETA STANDARD DEVIATION COEFFICIENT OF VARIATION

AXIS BANK BHEL CAIRN CHAMBAL FERTILISERS DLF GMR HDIL ICICI BANK IDBI IDEA IDFC IFCI INFOSYS ISPAT JP ASSOCIATES MTNL NTPC ONGC POWER GRID RELIANCE CAPITAL RELIANCE COMMUNICATION RELIANCE INDUSTRIES RELIANCE INFRASTRUCTURE RELIANCE PETROLEUM RELIANCE POWER RANBAXY RENUKA RNRL SAIL SATYAM SBI STER TATA MOTORS TATA TELESERVICES UNITECH

1.69 1.17 0.2190 8 1.693 0.175 1.416 0.86 1.699 1.093 0.44 1.696 1.81 0.7006 1.407 1.716 0.47 0.639 0.815 1.161 1.861 1.413 1.0369 2.091 0.8271 1.594 0.4678 1.197 2.0274 1.0728 0.6713 1.3103 0.7093 0.9843 0.994 1.6063

57.006 103.67 24.456 9.7633 46.16 13.566 87.542 78.681 6.369 10.073 15.342 9.103 141.955 3.149 19.246 4.637 9.925 59.023 7.1909 122.35 51.536 112.699 123.994 7.627 26.1 39.305 9.379 12.75 12.622 46.056 112.282 91.445 55.443 2.497 19.433

8.34 6.917 9.574 13.387 9.85 14 17.77 11.639 8.755 10.65 13.585 19.489 8.125 12.585 11.55 4.919 5.99 6.622 8.308 11.19 10.64 5.22 13.3 4.53 16.108 7.637 8.641 15.725 8.761 10.377 8.767 12.902 12.151 9.55 11.05

INTERPRETATION
The profit by investing in purchasing of options in derivative market of a particular company is directly proportional to the fluctuation in price of share of that

company in the cash market. In the research the nature of share price of all the companies are made by studying the share prices of companies in last 2 months .By applying statistical tools, the estimation of fluctuation in prices of shares in future is done. The companies which were highly fluctuating last year are suggested for investment

Mathematical expression:

P F
Where P=profit. F=fluctuation in share price

SUGGESTIONS
On the basis of the above research study following companies are suggested for purchasing of options in derivative market since the fluctuation in these companies are higher as compare to other companies.

1. 2. 3. 4. 5. 6. 7.

STRATEGIES TO HEDGE THE FUND

While investing in buying the options in derivative market the investors should apply strategy that will give return at comparatively low risk.

1. Investors may buy call and put options of particular company in same quantity. 2. If investor has bought future option, a put option may be purchased in order to hedge the fund. 3. If investor has sold future option, a call option may be purchased in order to hedge the fund. 4. If investor has invested in the shares of a particular company for long term. The fund can be hedged by purchasing put option to safeguard against short term volatility.

IMPLICATION
The above research study estimates the nature of share prices of companies regarding fluctuation. Thus it guides the investors about in which companies they should invest in. Apart from investment derivative has also been used as an

instrument to hedge other investment. The study also gives the information of the companies in which it will beneficial to hedge the funds.

By applying investment strategy investors can safeguard themselves from losses. One investment may cover the losses that may occur due to the other investment. In this way funds can be invested in a way that ensures higher return to investors at comparatively lower risk.

EXAMPLE:
Suppose an investor purchase call and put option of suggested companies. As per our estimation in the study the prices of shares will increase/decrease to a high extent, since the nature of share of these companies are highly volatile. Let us consider various possibilities.

CASE I. Price of share increases in the cash market.

There will be loss on purchasing of put option. Loss = price of put option at the time of purchasing.

There will be profit on purchasing of call option. Profit = Increase in prices of shares.

CASEII: Price of share decreases in the cash market.

There will be loss on purchasing of call option. Loss = price of call option at the time of purchasing.

There will be profit on purchasing of put option. Profit = Increase in prices of shares.

LIMITATIONS
Share prices of companies are influenced by many factors like performance of company, government policies, international market, interest rates, inflation, investment of foreign investors, and overall performance of sensex etc. Thus the nature of the companies may not be exactly as expected in the research study.

The above research is for short term only as data keeps on changing with market conditions and investor has to react accordingly.

REFERENCES
BOOKS: Elhance D.N, Elhance veena, Fundamental of Statistics.
1. 2.

NCFM book, Derivative Market (dealer) module. Kothari C.R., Research Methodology methods and techniques.

WEB SITES:
1. 2. 3.

www.nseindia.com. www.myiris.com. www.google.co.in.

Appendices
1. 2. 3. Last Thursday of every month is expiry day of option. Therefore closing price of last Thursday was taken for the study. Brokerage has to be given for trading in derivative market. Other formula may also be applied for calculating standard deviation.

4.

Example of calculation of standard deviation, beta and coefficient of variation is shown below:

Symbol RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R

Serie s EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ

Date 2-Jun-08 3-Jun-08 4-Jun-08 5-Jun-08 6-Jun-08 9-Jun-08 10-Jun08 11-Jun08 12-Jun08 13-Jun08 16-Jun08 17-Jun08 18-Jun08 19-Jun08 20-Jun08 23-Jun08

Close Price (Y) 228.6 218.75 202.6 198.6 193.6 185.15 182.25 182.3 186.15 187.65 184.7 190.95 186.35 180.9 174.95 162.6

clo*clo 52257.96 47851.5625 41046.76 39441.96 37480.96 34280.5225 33215.0625 33233.29 34651.8225 35212.5225 34114.09 36461.9025 34726.3225 32724.81 30607.5025 26438.76

% CHANGE(Y)

Close 4739.6

% CHANGE(X)

X*X 0.25004 2 7.63413 2 3.96848 5 1.10438 8 7.51331 8 1.29146 6 2.75062 7 0.12122 5 0.24025 5 1.50418 1 3.09944 8 2.30220 1 2.90851 9 12.103 3.48407 8

X*Y

-4.3088364 7.3828571 4 1.9743336 6 2.5176233 6 4.3646694 2 -1.5662976 0.0274348 42 2.1119034 56 0.8058017 73 1.5720756 7 3.3838657 28 2.4090075 9 2.9246042 4 3.2891100 1 7.0591597

4715.9 4585.6 4676.9 5 4627.8 4500.9 5 4449.8 4523.6 4539.3 5 4517.1 4572.5 4653 4582.4 4504.2 5 4347.5 5 4266.4

-0.50004 -2.76299 1.992106 -1.0509 -2.74104 -1.13643 1.658502 0.348174 -0.49016 1.226451 1.760525 -1.5173 -1.70544 -3.47894 -1.86657

2.1546

20.3987 8

3.93308

2.64576 7

11.9637 5 1.77998 2 0.04550 1

0.73531 0.39497

1.92807

5.95738

3.65518 9

4.98773 2

11.4426 1 13.1764 1

RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R

EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ EQ

24-Jun08 25-Jun08 26-Jun08 27-Jun08 30-Jun08 1-Jul-08 2-Jul-08 3-Jul-08 4-Jul-08 7-Jul-08 8-Jul-08 9-Jul-08 10-Jul08 11-Jul08 14-Jul08 15-Jul08 16-Jul08 17-Jul08 18-Jul08 21-Jul08

152.7 155.6 154.05 145 136.65 127.55 132.35 130.35 135.95 135.6 136.9 148.65 147.75 140.6 137.6 131.05 127.85 131.8 132.3 132.2

23317.29 24211.36 23731.4025 21025 18673.2225 16269.0025 17516.5225 16991.1225 18482.4025 18387.36 18741.61 22096.8225 21830.0625 19768.36 18933.76 17174.1025 16345.6225 17371.24 17503.29 17476.84

6 6.0885608 9 1.8991486 57 0.9961439 6 -5.874716 5.7586206 9 -6.6593487 3.7632301 06 1.5111446 9 4.2961258 15 0.2574475 9 0.9587020 65 8.5829072 32 0.6054490 4 -4.8392555 2.1337126 6 4.7601744 2 -2.4418161 3.0895580 76 0.3793626 71 0.0755857 9

4191.1 4252.6 5 4315.8 5 4136.6 5 4040.5 5 3896.7 5 4093.3 5 3925.7 5 4016 4030 3988.5 5 4157.1 4162.2 4049 4039.7 3861.1 3816.7 3947.2 4092.2 5 4159.5

-1.76495 1.468588 1.486132 -4.15214 -2.32314 -3.55892 5.04523 -4.09445 2.298924 0.348606 -1.02854 4.225846 0.122682 -2.71972 -0.22969 -4.42112 -1.14993 3.419184 3.674757 1.64335

3.11506 3 2.15675 1 2.20858 9 17.2402 4 5.39696 12.6659 2 25.4543 5 16.7644 9 5.28505 1 0.12152 6 1.05788 6 17.8577 8 0.01505 1 7.39685 3 0.05275 6 19.5463 1 1.32234 2 11.6908 2 13.5038 4 2.7006

10.7460 3 2.78906 7

-1.4804 24.3926 3

13.3780 6

23.7001 18.9863 6

6.1873 9.87646 6

0.08975 0.98606 36.2700 5

0.07428

13.1614

0.49008 5

21.0453 2.80792 1 10.5637 7 1.39406 6

0.12421

RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R RPOWE R

EQ EQ EQ EQ EQ EQ EQ EQ

22-Jul08 23-Jul08 24-Jul08 25-Jul08 28-Jul08 29-Jul08 30-Jul08 31-Jul08

142.75 171.1 176 168.85 169.2 154.15 163.15 165.6 7129.4

20377.5625 29275.21 30976 28510.3225 28628.64 23762.2225 26617.9225 27423.36 1185163.45

7.9803328 29 19.859894 92 2.8638223 26 -4.0625 0.2072845 72 8.8947990 5 5.8384690 24 1.5016855 65 26.778320 3 BETA=1.59 4 S.D.=26.10 0 C.V.=16.10 8

4240.1 4476.8 4433.5 5 4311.8 5 4332.1 4189.8 5 4313.5 5 4332.9 5

1.937733 5.582416 -0.96609 -2.74498 0.469636 -3.28363 2.952373 0.449746 -7.57613

3.75480 9 31.1633 6 0.93333 3 7.53490 8 0.22055 8 10.7822 1 8.71650 6 0.20227 1 279.136 5

15.4637 5 110.866 2 2.76672 11.1514 8 0.09734 8

29.2072 17.2373 4 0.67537 6

447.652 7

BETA = (nxy-x*y)/ (nx2-(x2)) Standard deviation = [((X*X)-(X*X)/N]/N Coefficient .of variation= (standard deviation /X*)*100
BETA= (44* 447.6527- (-7.57613* -26.7783203))/ (44*279.1365-(-7.57613)) =1.594 STANDARD DEVIATION= ((1185163.45*1185163.45)-(7129.4*7129.4)/44)44 =26.100

COEFFECIENT OF VARIATION= (26.100/162.031)*100 =16.108 MEAN=7129.4/44 =162.031

5.

The price of call and put are very less as compare to price of share in cash market.