INDIAN DERIVATIVE MARKETING

Abstract

Stock exchanges are the pivot of capital market. They serve as the channels through which primary issues are offered to the investing public and they provide the mechanism through outstanding securities are traded. While there we only 9 recognized stock exchanges in 1980, the number had gone up to 23 by the end of 2006. Minimize Disasters with derivatives

At the level of exchanges, position limits and surveillance procedures should be sound. At the level of clearinghouse, margin requirements should be stringently enforced, even when dealing with a large institution like Baring.

At the level of individual companies with positions on the market, modern risk measurement systems should be established alongside the creation of capabilities in trading in derivatives. The basic idea, which should be steadfastly used when thinking about returns, is that risk also merits measurement.

Options margining work:

In the case of futures, both short and long are charged initial margin, and after this, both sides pay daily mark-to-mark margin. This is not how options work. In the options market, the long pays up the full price of the options on the same day, and the short puts up initial margin. After this, the long is relieved of all responsibilities to his position, and the short pays daily mark-to-market margin.

The initial margin of the option short is the largest loss that he can suffer with a one-day price change that goes against his. This is calculated using theoretical option-pricing formulas.

Derivatives allow a shifting of risk from a person who does not want to dear the risk to a person who wants to dear the risk. The only investment decision that can be made is whether to be in a certain area of business or not. For example, if a garment exporter dislikes currency risk, the only choice that he faces (in a world before derivatives) is whether to be in garment export or not. Which derivatives, he has the ability and choice to insure against currency exposure. And he is able to do this by trading this exposure with others in the economy that is equipped to deal with it.

Both futures and options markets have a significant impact upon the informational efficiency of financial markets. In the case of futures:

1. The simplest and most direct effect is that the launch of derivatives market is correlated with improvements in market efficiency in the underlying market. This improved market efficiency means that the market prices of individual securities are more informative.

2. Once futures markets appear, a certain de-linking of roles in the two markets is observed. The cash market caters to relatively non-speculative orders, and the futures markets takes over the major brunt of price discovery. The futures market is better suited for this role, because of high liquidity and leverage. Whenever news strikes, it first appears as a shock in the futures market prices, which arbitrage then carries into the cash market.

3. Another unique feature applies for the market index. In today’s economy, speculation on the level of the index is difficult, because a tradable index does not exist.

Hence informed speculators might try to take positions on individual securities in order to implement views about the index, but this is difficult because of higher transactions costs. 39 Index futures will hence improve the informational quality of the market index.

In the case of options:

1. Options are important to the market efficiency of the underlying in much the same way that futures are important. 2. In addition, options play one unique role of revealing the market’s perception of volatility. High-quality volatility forecasts have serious ramifications for decisions in portfolio optimization, production planning physical investment decisions, etc.

By using the option price in the market, it is possible to infer the market’s consensus view about volatility through a simple formula. This is a completely unique role that options play that neither the cash market nor the futures markets can possibly play. This is a very important reason why security options are important. I f options of TISCO existed; the entire market would be able to observe the price of options on the market, and infer a very good forecast about volatility on TISCO in the coming weeks and months.