Derivatives

1. Derivatives • Derivatives are financial instruments that derive their value from an underlying asset. The underlying assets can be equity, currency or a commodity. • During last 10 years the financial environment of the country has witnessed an unprecedented growth along with the high degree of uncertainty and variability. • Derivatives were introduced in the country in June 2000.. During the year 2003, the government has granted permission to start buying & selling in commodity futures.

2. Benefits of Derivative Trading • Derivatives are those financial instruments which provides the ample scope of trading in capital market without holding a large quantity of stock i.e. without high investment. Derivative instruments also protects the portfolio of the investor by paying a small premium amount. It gives the significant scope of making profits with minimum amount of risk involved. The advantage of derivative trading can be summarised as follows : • (1) Advantage of Leverage • 2) Advantage of Hedging • (3) Advantage of Arbitrage • (4) Power to defer • (5) Power to earn Fixed Income

3. Stock Exchanges : A barometer of Economy • Stock exchange is a place of transacting business between the authorised members of the exchange. No stock broker shall buy, sell or deal in securities unless he holds a certificate granted by the Securities and Exchange Board of India. • The main function of any stock exchange is to act as a medium of transaction of securities from one hand to another freely, at a price decided by the forces of demand and supply. The important economic functions of a stock exchange are as follows : • 1. Providing regular market place to transact securities and acting as an intermediary between buyers and sellers. • 2. Encouraging investment habit in the general public and thus developing capital formation. • 3. Creating a mechanism for continuous evaluation of the securities and thus providing stability in the prices. • 5. Providing historical data for the evaluation of market trend of the security and performance of the company.

4. Trading • Trading in derivatives is highly risky unless it is protected by certain strategy. The minimum contract size and the market lot of derivative trading are very high for a small investor to deal in. the volatility of the underlying and the premium/discount on the market price also effects the future price. High open-interest on a particular expiry date also increases the volatility of the market. It is therefore required to give close look on the various factors of derivative trading

5. Open interest : • Open interest is the total number of future and option contracts of a given security and on a given day that have not been offset by an opposite future or option transaction. Each open interest has a buyer and a seller, but for calculation of open interest, only one side of contract is counted. A high open interest position in any security indicates good invester's interest in that security thus ensures good liquidity. The open interest of current months are higher than the near or far month. this position simply indicates that the investors in derivative market are generally interested in short-term gain rather than long-term profitability

6. Put-Call Ratio : The put-call ratio is a indicator of market sentiment. It is the ratio of number of puts to the number of calls in the market on a given day.

7. Time to expiry : • Time to expiry is the another factor of consideration in case of derivative trading. In India, the derivatives are traded for three months trading cycle i.e. current near and far months. In practice, the most active instruments are of current months and the trades for the far month are very rare. In fact, the majority of the volumes are concentrated on the current and near month contracts.

8. Trade Volumes and Liquidity : • The strength of the scrip is dependent upon the volume of trade. Higher volume gives higher liquidity and ill-liquid stocks are generally traded in low volumes.

9. Clearing & Settlement (Derivatives) • National Securities Clearing Corporation Limited (NSCCL) is the clearing and settlement agency for all deals executed on the Derivatives (Futures & Options) segment. NSCCL acts as legal counter-party to all deals on NSE's F&O segment and guarantees settlement.A Clearing Member (CM) of NSCCL has the responsibility of clearing and settlement of all deals executed by Trading Members (TM) on NSE, who clear and settle such deals through them.

10. Clearing Members • A Clearing Member (CM) of NSCCL has the responsibility of clearing and settlement of all deals executed by Trading Members (TM) on NSE, who clear and settle such deals through them. Primarily, the CM performs the following functions: • Clearing – Computing obligations of all his TM's i.e. determining positions to settle. • Settlement - Performing actual settlement. Only funds settlement is allowed at present in Index as well as Stock futures and options contracts • Risk Management – Setting position limits based on upfront deposits / margins for each TM and monitoring positions on a continuous basis

11. Types of Clearing Members • Trading Member Clearing Member (TM-CM)A Clearing Member who is also a TM. Such CMs may clear and settle their own proprietary trades, their clients’ trades as well as trades of other TM’s • Professional Clearing Member (PCM)A CM who is not a TM. Typically banks or custodians could become a PCM and clear and settle for TM’s. • Self Clearing Member (SCM)A Clearing Member who is also a TM. Such CMs may clear and settle only their own proprietary trades and their clients’ trades but cannot clear and settle trades of other TM’s.

12. Clearing Mechanism A Clearing Member's open position calculation is arrived by aggregating the open position of all the Trading Members (TM) and all custodial participants clearing through him. A TM's open position in turn includes his proprietary open position and clients’ open positions.

13. Proprietary / Clients’ Open PositionWhile entering orders on the trading system, TMs are required to identify them as proprietary (if they are own trades) or client (if entered on behalf of clients) through 'Pro / Client' indicator provided in the order entry screen. The proprietary positions are calculated on net basis (buy - sell) and client positions are calculated on gross of net positions of each client i.e., a buy trade is off-set by a sell trade and a sell trade is off-set by a buy trade.

14. Corporate Actions Adjustment The basis for any adjustment for corporate actions shall be such that the value of the position of the market participants, on the cum and ex-dates for the corporate action, shall continue to remain the same as far as possible. This will facilitate in retaining the relative status of positions viz. in-the-money, at-the-money and out-of-money. This will also address issues related to exercise and assignments.

15. Corporate Actions to be adjustedThe corporate actions may be broadly classified under stock benefits and cash benefits.The various stock benefits declared by the issuer of capital are:* Bonus* Rights* Merger / De-merger* Amalgamation* Splits* Consolidations

16. Clearing Banks NSCCL has empanelled 11 clearing banks namely Canara Bank, HDFC Bank, IndusInd Bank, ICICI Bank, UTI Bank, Bank of India, IDBI Bank, Hongkong & Shanghai Banking Corporation Ltd., Standard Chartered Bank, Kotak Mahindra Bank and Union Bank of India.Every Clearing Member is required to maintain and operate a clearing account with any one of the empanelled clearing banks at the designated clearing bank branches. The clearing account is to be used exclusively for clearing & settlement operations.