ACKNOWLEDGEMENT

DECLARATION

I, Dominic Anupam Sarkar, hereby declare that this dissertation titled as Future
& Option market, is my original work under the guidance of Prof. Binita
Mukherjee towards partial fulfillment of the requirements for the PGPBM course
of International School of Business & Media. This report has not been submitted
earlier for the award of Degree/Diploma/Programme by any other University/Bschool.

Place-Bangalore
Date-

(Signature of Student)
DOMINIC ANUPAM SARKAR
1

CONTENT
Serial

Topic

No.

Page No.

1.

INTRODUCTION

2.

CORPORATE HIERARCHY

4-6

3.

DIFFRENCE BETWEEN CASH

MARKET
AND
FUTURE
MARKET

4.

FUTURE CONTRACTS

8-12

5.

OPTIONS CONTRACT

13-19

6.

TERMINOLOGIES IN THE
STOCK MARKET

20

7.

CONCLUSION

21-22

8.

BIBILOGRAPHY

23

9.

NOTES

24

INTRODUCTION
The trading on the stock exchange is an online process.
NSE introduced a nationwide online fully automated screen based trading system
(SBTS or Terminal). There are 19 stock exchanges all across India. NSE became
the leading stock exchange in the country, impacting the fortune of other stock
exchanges and forcing them to adopt screen based trading system. Almost 100% of
trading takes place through electronic order matching. It provides full anonymity
by accepting orders, big or small form without revealing their identity, thus
providing the equal access to everybody.

The CAPITAL MARKET SYSTEM has 4 types of markets.

1. Normal market it consists of various book types wherein orders are
segregated as regular lot orders, special negotiated trade orders and stop loss
orders depending on their attributes.
2. Odd lot market it is used for the limited physical market. The exchange has
provided the facility for such trading in the physical scales not exceeding
500 shares. Orders get matched when both the price and the quantity match
& on time priority i.e. orders which have come into the system before will
get matched first.
3. Retail debt market it is facility on the NEAT system of capital market
segment is used for transactions in retail debt market session.
4. Auction market in an auction market auctions are initiated by the exchange
on the behalf of trading members for the settlement related regions.
There are 3 types of participants in the auction market as follows
a. Initiator the party who initiates the auction process is called the
Initiator.
b. Competitor the party who enters on the same side as of the initiator is
called Competitor.
c. Solicitor the party who enters on the opposite side as of the initiator is
called the Solicitor.

CORPORATE HIERARCHY
3

The trading member has the facility of defining hierarchy among its users of NEAT
system (National Exchange For Automated Trading). The hierarchy comprises of
Corporate
Manager

Branch
One

Branch
Two

Dealer
Two

Dealer
One

Dealer
One

Dealer
Two

MARKET PHASES

The system is normally made available for the trading on all days except Saturdays
and Sundays and other holidays approved by the exchange.
1. Opening the trading members perform the following certain activities after
login to the NEAT system.
a. Setup market watch
b. Viewing inquiry screen
However at the point of time when the market is opening, the trading members
cannot login. He / She cannot perform the trading activities till the market is
opened.
2. Open Phase the phase is signified by the start of trading. It allows all the
securities to be opened. During this phase the orders are matched on

continuous basis. Trading in all instruments is allowed unless prohibited by

the exchange.
3. Market Close this phase signifies the closing of a market. It also says that
no further orders will be accepted.
4. Surcon (surveillance and control) this phase is mainly characterized by the
inquiry activities performed by the user.

NEAT SCREEN

Title Bar it displays trading system i.e. NEAT, the data and the current
time.
Ticker Window it displays information on all trades in the system as and
when it takes place. Securities in ticker can be selected for each market type.
On the extreme right of the ticker is the on-line index window that displays
the index value of NSE indices namely
S&P CNX Nifty, S&P CNX
Defty, CNX IT, Bank Nifty, etc. the users can scroll within these and view
the index value respectively.
Tool Bar it has many functional buttons which can be used with the mouse
for quick access to various functions such as Buy Order Entry, Sell Order
Entry, Market By Price (MBP), Activity Log (AL), Order Status (OS),
Market Watch (MW), Snap Quote (SQ), Market Movement (MM), Market
Inquiry (MI), Auction Enquiry (AE), Order Modification (OM), Order
Cancellation (OCXL), Security List, Net Position, On-Line Backup,
Supplementary Menu, Index Inquiry, Index Broadcast And Help.
Market Watch Window it displays trading information for the selected
securities.
Inquiry Window this screen enables the user to view information such as
MBP, PT, OO, AC, etc.
Snap Quote it allows a trading member to get instantaneous market
information on any desired security.
Order/Trade Window allows the user to enter/modify/cancel orders.
Message Window it enables the user to view messages broadcast by the
exchange such as corporate auctions, any market news, auction related
5

information etc. It includes other messages such as order confirmation, order

modification, order cancellation etc.

Important things to be noted while trading

In any kind of capital market two conditions occurs which are as follows
1. Buyers want to buy at low price
2. Seller wants to sell at high price
Percentage
Change

Last Day Closing

Price
__________________

* 100

Last Traded
Price
Average Traded (AT) = high + low
2
Volatility - risk in financial markets is the likelihood of fluctuations in the
exchange rate of currencies. Therefore, it is a probability measure of the
thread; an exchange rate movement is to an investors portfolio in a foreign
currency.
Market Cap = Share Price * no. of shares outstanding

Difference Between Cash Market And Future Market

6

Basis

Cash Market

Future Market

Trading

Stocks

Stocks, Index, Commodities

Quantity

Minimum 1 Share

Lot size is fixed by the

exchange (different for stocks,
indexes and commodities)

Time Period

Not Defined

Defined expiry on last

Thursday of every month

Investment

More

Less

Delivery

Delivery settled

Cash settled

Risk And Reward

Less Risk, Less Reward

Unlimited Risk or Reward

FUTURE CONTRACTS

The futures market is a centralized marketplace for buyers and sellers from around
the world who meet and enter into futures contracts. Pricing can be based on an
open cry system, or bids and offers can be matched electronically. The futures
contract will state the price that will be paid and the date of delivery.
A futures contract is an agreement between two parties: a short position - the party
who agrees to deliver and a long position - the party who agrees to receive.

PARTIES OF FUTURES
Trader

Short

Long

The Hedger Secure a price now to Secure a price now to

protect against future protect against future
declining prices
rising prices
The
Speculator

Secure a price now in Secure a price now in

anticipation of declining anticipation of rising
prices
prices

Profit And Loss - Cash Settlement

8

The profits and losses of a futures contract depend on the daily movements of the
market for that contract and are calculated on a daily basis. For example, say the
futures contracts for wheat increases to $5 per bushel the day after the above
farmer and bread maker enter into their futures contract of $4 per bushel. The
farmer, as the holder of the short position, has lost $1 per bushel because the
selling price just increased from the future price at which he is obliged to sell his
wheat. The bread maker, as the long position, has profited by $1 per bushel
because the price he is obliged to pay is less than what the rest of the market is
obliged to pay in the future for wheat.
On the day the change occurs, the farmer's account is debited $5,000 ($1 per
bushel X 5,000 bushels) and the bread maker's account is credited by $5,000 ($1
per bushel X 5,000 bushels). As the market moves every day, these kinds of
adjustments are made accordingly. Unlike the stock market, futures positions are
settled on a daily basis, which means that gains and losses from a day's trading are
deducted or credited to a person's account each day. In the stock market, the capital
gains or losses from movements in price aren't realized until the investor decides to
sell the stock or cover his or her short position.
As the accounts of the parties in futures contracts are adjusted every day, most
transactions in the futures market are settled in cash, and the actual physical
commodity is bought or sold in the cash market. Prices in the cash and futures
market tend to move parallel to one another, and when a futures contract expires,
the prices merge into one price. So on the date either party decides to close out
their futures position, the contract will be settled. If the contract was settled at $5
per bushel, the farmer would lose $5,000 on the futures contract and the bread
maker would have made $5,000 on the contract.

But after the settlement of the futures contract, the bread maker still needs wheat to
make bread, so he will in actuality buy his wheat in the cash market (or from a
wheat pool) for $5 per bushel (a total of $25,000) because that's the price of wheat
in the cash market when he closes out his contract. However, technically, the bread
maker's futures profits of $5,000 go towards his purchase, which means he still
pays his locked-in price of $4 per bushel ($25,000 - $5,000 = $20,000). The
farmer, after also closing out the contract, can sell his wheat on the cash market at
$5 per bushel but because of his losses from the futures contract with the bread
maker, the farmer still actually receives only $4 per bushel. In other words, the
9

farmer's loss in the futures contract is offset by the higher selling price in the cash
market - this is referred to as hedging.
Now that you see that a futures contract is really more like a financial position, you
can also see that the two parties in the wheat futures contract discussed above
could be two speculators rather than a farmer and a bread maker. In such a case,
the short speculator would simply have lost $5,000 while the long speculator
would have gained that amount. In other words, neither would have to go to the
cash market to buy or sell the commodity after the contract expires.)
Economic Importance of the Futures Market
Because the futures market is both highly active and central to the global
marketplace, it's a good source for vital market information and sentiment
indicators.

Price Discovery - Due to its highly competitive nature, the futures market has
become an important economic tool to determine prices based on today's and
tomorrows estimated amount of supply and demand. Futures market prices depend
on a continuous flow of information from around the world and thus require a high
amount of transparency. Factors such as weather, war, debt default, refugee
displacement, land reclamation and deforestation can all have a major effect on
supply and demand and, as a result, the present and future price of a commodity.
This kind of information and the way people absorb it constantly changes the price
of a commodity. This process is known as price discovery.
Risk Reduction - Futures markets are also a place for people to reduce risk when
making purchases. Risks are reduced because the price is pre-set, therefore letting
participants know how much they will need to buy or sell. This helps reduce the
ultimate cost to the retail buyer because with less risk there is less of a chance that
manufacturers will jack up prices to make up for profit losses in the cash market.

Futures Fundamentals: Strategies

10

Essentially, futures contracts try to predict what the value of an index or

commodity will be at some date in the future. Speculators in the futures market can
use different strategies to take advantage of rising and declining prices. The most
common are known as going long, going short and spreads.
Going Long
When an investor goes long - that is, enters a contract by agreeing to buy and
receive delivery of the underlying at a set price - it means that he or she is trying to
profit from an anticipated future price increase.
For example, let's say that, with an initial margin of $2,000 in June, Joe the
speculator buys one September contract of gold at $350 per ounce, for a total of
1,000 ounces or $350,000. By buying in June, Joe is going long, with the
expectation that the price of gold will rise by the time the contract expires in
September.
By August, the price of gold increases by $2 to $352 per ounce and Joe decides to
sell the contract in order to realize a profit. The 1,000 ounce contract would now be
worth $352,000 and the profit would be $2,000. Given the very high leverage
(remember the initial margin was $2,000), by going long, Joe made a 100% profit!
Of course, the opposite would be true if the price of gold per ounce had fallen by
$2. The speculator would have realized a 100% loss. It's also important to
remember that throughout the time that Joe held the contract, the margin may have
dropped below the maintenance margin level. He would, therefore, have had to
respond to several margin calls, resulting in an even bigger loss or smaller profit.
Going Short
A speculator who goes short - that is, enters into a futures contract by agreeing to
sell and deliver the underlying at a set price - is looking to make a profit from
declining price levels. By selling high now, the contract can be repurchased in the
future at a lower price, thus generating a profit for the speculator.
Let's say that Sara did some research and came to the conclusion that the price of
oil was going to decline over the next six months. She could sell a contract today,
in November, at the current higher price, and buy it back within the next six
months after the price has declined. This strategy is called going short and is used
when speculators take advantage of a declining market.
Suppose that, with an initial margin deposit of $3,000, Sara sold one May crude oil
11

contract (one contract is equivalent to 1,000 barrels) at $25 per barrel, for a total
value of $25,000.
By March, the price of oil had reached $20 per barrel and Sara felt it was time to
cash in on her profits. As such, she bought back the contract which was valued at
$20,000. By going short, Sara made a profit of $5,000! But again, if Sara's research
had not been thorough, and she had made a different decision, her strategy could
have ended in a big loss.
Spreads
As you can see, going long and going short are positions that basically involve the
buying or selling of a contract now in order to take advantage of rising or declining
prices in the future. Another common strategy used by futures traders is called
spreads.
Spreads involve taking advantage of the price difference between two different
contracts of the same commodity. Spreading is considered to be one of the most
conservative forms of trading in the futures market because it is much safer than
the trading of long/short (naked) futures contracts.
There are many different types of spreads, including:
Calendar Spread - This involves the simultaneous purchase and sale of
two futures of the same type, having the same price, but different delivery
dates.
Intermarket Spread - Here the investor, with contracts of the same
month, goes long in one market and short in another market. For example,
the investor may take Short June Wheat and Long June Pork Bellies.
Inter-Exchange Spread - This is any type of spread in which each
position is created in different futures exchanges. For example, the investor
may create a position in the Chicago Board of Trade (CBOT) and the
London International Financial Futures and Options Exchange (LIFFE).

Options Basics: Introduction

12

Nowadays, many investors' portfolios include investments such as mutual

funds, stocks and bonds. But the variety of securities you have at your disposal
does not end there. Another type of security, called an option, presents a world of
opportunity to sophisticated investors.
The power of options lies in their versatility. They enable you to adapt or adjust
your position according to any situation that arises. Options can be as speculative
or as conservative as you want. This means you can do everything from protecting
a position from a decline to outright betting on the movement of a market or index.

This versatility, however, does not come without its costs. Options are complex
securities and can be extremely risky.
Option trading involves risk, especially if you don't know what you are doing.
Because of this, many people suggest you steer clear of options and forget their
existence.
On the other hand, being ignorant of any type of investment places you in a weak
position. Perhaps the speculative nature of options doesn't fit your style. No
problem - then don't speculate in options. But, before you decide not to invest in
options, you should understand them. Not learning how options function is as
dangerous as jumping right in: without knowing about options you would not only
forfeit having another item in your investing toolbox but also lose insight into the
workings of some of the world's largest corporations. Whether it is to hedge the
risk of foreign-exchange transactions or to give employees ownership in the form
of stock options, most multi-nationals today use options in some form or another.

Option Market
13

Definition - An option is a contract that gives the buyer the right, but not the
obligation, to buy or sell an underlying asset at a specific price on or before a
certain date. An option, just like a stock or bond, is a security. It is also a binding
contract with strictly defined terms and properties. Options are traded only on
premium.

Types of Options

Call Option
14

A call gives the holder the right to buy at a certain price within a specific period of
time. Calls are similar to having a long position on a stock. Buyers of calls hope
that the stock will increase substantially before the option expires.
This has direct relationship with cash market i.e. if the price of the share traded
goes up in the cash market one earns profit here.

Put Option
A put gives the holder the right to sell (no obligation) at a certain price within a
specific period of time. Puts are very similar to having a short position on a stock.
Buyers of puts hope that the price of the stock will fall before the option expires.
This has the indirect relationship with the cash market i.e. if the price of the share
traded goes down in cash market one earns profit here.

Exercise Date
The date at which the option is exercised

Strike Price

At the time of entering into the contract, the parties agree upon a price at which the
underlying asset may be bought or sold. At this price the buyer of a call option can
buy the asset from the seller and the buyer of the put option can sell the asset to the
writer of the option. The strike price is fixed by the exchange. It is further
categorized in three main heads
1. In the money less than market price
2. At the money at the market price
3. Out of the money above the market price
15

These three are taken into the picture because of hedging.

Expiration period
It is the period being specified by the exchange during which the option can be
exercised or traded. Depending on the expiration period, an option can be shortterm or long-term in nature.

16

Now let us understand in brief the software used to trade in

stock market.
Software name ODIN (made by financial technologies) WHICH IS USED IN
Fortune Financial Services India Private Limited.
Snapshot of how the software window looks

17

Operation of the software

1. Press F1 to buy
2. Press F2 to sell
3. Press F3 to view order book
4. To modify the pending order Press F3 and select the particular order then
press Shift + F2 to modify (buy order or sell order)
5. To cancel the pending order Press F3 and select the particular order then
press Shift + F1 to cancel the order
6. Press F8 for confirmation (confirmation of transaction being settled)
7. Press Shift +F7 to know about corporate benefits (company information)
8. Press F5/F6 to go to book where data about total buying and total selling can
be viewed
9. Press F10 to view list of orders

Strategies to hedge in option market

18

1. Buying a call when you are bullish.

2. Buying a put when you are bearish.
3. Buying a lower call and selling a higher call.
4. Buying higher put and selling a lower put.
5. Buying a put and call at the same strike price Straddle
6. Selling put and sell a call at same strike price Range Bound Straddle
7. Buying at higher call and buying a lower put Strangle
8.

Buying a call at X strike price and selling two calls at x+1 strike
price then buying one more call at X+2 Butterfly

Terms and terminologies in stock market

19

1. Arbitrage buy in one counter and sell in another with a very small price
difference. This can only be profitable if transactions are done in bulk.
2. Trade to trade buy today and sell only after the delivery.
3. Portfolio management basket of shares you buy.
4. Hedging minimization of risk.
5. Freezing concept (in cash market) it is a limit set by the exchange for a
particular script in a day. (the limits are only set for the stocks which do not
trade in F&O segment)
6. Swaps - A swap is an agreement between two parties to exchange a sequence
of cash flows.
7. Speculation this concept is for day traders. (used for intraday trading)
8. Risk Management acquiring derivatives that will offset (hedge) risk
exposure to interest rate changes, foreign currency movements, and
commodity prices. May be hedge of current exposure or hedge of future
exposure.
9. Spot Price the price at which an asset trades in the cash market
10.Futures Price the price at which the futures contract trades in the futures
market
11.Long position any contract bought is long position. (open contract)
12.Short Position any contract sold is short position. (open contract)

CONCLUSION
20

The futures market is a global marketplace, initially created as a place for

farmers and merchants to buy and sell commodities for either spot or future
delivery. This was done to lessen the risk of both waste and scarcity.
Rather than trade in physical commodities, futures markets buy and sell
futures contracts, which state the price per unit, type, value, quality and
quantity of the commodity in question, as well as the month the contract
expires.
The players in the futures market are hedgers and speculators. A hedger tries
to minimize risk by buying or selling now in an effort to avoid rising or
declining prices. Conversely, the speculator will try to profit from the risks
by buying or selling now in anticipation of rising or declining prices.
The CFTC and the NFA are the regulatory bodies governing and monitoring
futures markets in the U.S. It is important to know your rights.
Futures accounts are credited or debited daily depending on profits or losses
incurred. The futures market is also characterized as being highly leveraged
due to its margins; although leverage works as a double-edged sword. It's
important to understand the arithmetic of leverage when calculating profit
and loss, as well as the minimum price movements and daily price limits at
which contracts can trade.
Going long, going short, and spreads are the most common strategies
used when trading on the futures market.
Once you make the decision to trade in commodities, there are several ways
to participate in the futures market. All of them involve risk - some more
than others. You can trade your own account, have a managed account or
join a commodity pool.

An option is a contract giving the buyer the right but not the obligation to
buy or sell an underlying asset at a specific price on or before a certain date.
Options are derivatives because they derive their value from an underlying
asset.
A call gives the holder the right to buy an asset at a certain price within a
specific period of time.
A put gives the holder the right to sell an asset at a certain price within a
specific period of time.

21

There are four types of participants in options markets: buyers of calls,

sellers of calls, buyers of puts, and sellers of puts.
Buyers are often referred to as holders and sellers are also referred to as
writers.
The price at which an underlying stock can be purchased or sold is called the
strike price.
The total cost of an option is called the premium, which is determined by
factors including the stock price, strike price and time remaining until
expiration.
A stock option contract represents 100 shares of the underlying stock.
Investors use options both to speculate and hedge risk.
Employee stock options are different from listed options because they are a
contract between the company and the holder. (Employee stock options do
not involve any third parties.)

BIBILOGRAPHY
22

1. KHAN M.Y., Corporate finance, Tata Mc Graw Hill

2. NCFM study materials
3. Web site reference:
Investopedia
Rediffmoney.com

NOTES
23

24