1. Introduction to Futures and Options Markets in India MANISH BANSAL Jeetay Investments Email: manish.bansal@jeetay.commanish.bansal@jeetay.com Phone: +91 98924 86751 www.jeetay.com To lead, one needs to be different and to be different, one needs to innovate strategically, on continuous basis.

2. 2. Introduction

3. 3. Great journey of Equity Derivatives year Average Daily Turnover in Rs. crore 2012-13113140.76 2011-12125902.54 2010-11115150.48 2009-1072392.07 2008-0945310.63 2007-0852153.3 2006-0729543 2005-0619220 2004-0510107 2003-048388 2002-031752 2001-02410 2000-0111 Having started in 2000, journey on Equity Derivatives volume growth has been a spectacular one. Data Source - NSE

4. 4. Great journey of Commodity Derivatives Commodity Derivatives, having started in 2003, have shown buoyancy and growth on continuous basis. Volume of other exchanges such as NCDED etc. are in addition to these nos. Year Turnover in Rs. Crore 2003*138 200493,432 20056,23,574 200620,25,664 200727,29,820 200842,84,653 200959,56,655 201086,96,869 20111,49,32,852 2012*56,98,492 * For part year. Data Source - MCX

5. 5. Great journey of Currency Derivatives Having started in 2008, market has witnessed significant growth in Currency Derivatives volume. Year Turnover in Rs. Crore 2008-09*1,62,272 2009-1017,82,608 2010-1134,49,787 2011-1246,74,989 2012-13*6,21,990 * For part year. Data Source - NSE

6. 6. Product Profile ProductsSettlement typeTenor Equity Derivatives Futures and options on indices (domestic and international) and stocks Cash settled ProductsMajorly 3 months products. Some products are available up to 5 yrs. Commodity Derivatives Commodities – Energy, Metals, Bullion, Oil and Seeds, Fiber, Weather etc. Compulsory delivery; Sellers’ option and Intention matching Products Up to 1 yr. products Foreign Exchange Four currency pairs – USDINR, GBPINR, EURINR and JPYINR. Cash settled Products in Indian Rs. up to 1 yr. products Interest RatesNotional bondDelivery based Productsup to 1 yr. products

7. 7. Product Profile MTM Circuit filtersPosition limits Equity DerivativesDailyOnly operational circuit filters Exist for market, members and clients Commodity Derivatives DailyOnly operational circuit filters Exist for members and clients Foreign ExchangeDailyOnly operational circuit filters Exist for members and clients Interest RatesDailyOnly operational circuit filters Exist for members and clients

8. 8. Regulatory Snapshot Regulatory goal is not to ensure that clients do not incur loss; But, to ensure that failure of any member does not affect integrity of the market. Adequate risk containment systems in place to avoid failures: –Robust on-line Margining System (IM and MTM). –Exposure limits linked to Liquid Net-worth –Position limits linked to underlying size and OI - Market Level, Trading/Clearing Member Level & Client Level Separation of clearing and trading activities. Compulsory collection of margins from clients. Continuous on-line monitoring of client level positions.

9. 9. Exchange Traded Vs. OTC Products profile UnderlyingExchange TradedOTC EquityVibrant market; $20-25 Bio average daily traded volume over last several months; Dominant player is NSE. Standalone OTC Derivatives don’t have legal support on enforceability. However, products like Equity Linked Debentures exist (access products). Outstanding - $5-7 Bio (Market estimates) CurrenciesVibrant market; $10-15 Bio average daily traded volume over last several months; Dominant players are NSE and MCX. Very vibrant market for variety of products and tenors. Corporates need to demonstrate the underlying transaction. CommoditiesVibrant market; $15-20 Bio average daily traded volume over last several months; Dominant player are MCX and NCDEX. Small market. Corporates allowed to hedge their risks. Dominant players are only offshore banks – Citi, DB, MS, Goldman etc. Corporates need to demonstrate the underlying transaction. RatesProducts exist on exchanges, but no volumes. Very vibrant market for variety of products and tenors. Corporates need to demonstrate the underlying transaction. CreditNot availableCDS just launched (Dec. 2011). Progress to be seen.

10. 10. OPPORTUNITIES TO CREATE VALUE THROUGH DERIVATIVES

11. 11. Esops – An opportunity Esops are essentially call options, issued to the employees. Today, either employee can exercise those options after vesting or let them expire worthless. Listing and trading of vested options would help the employees monetize their options without exercising them. Opportunity: Credit the vested options to employees in their Demat account. List and trade the vested options on Stock Exchanges.

12. 12. Rights – An opportunity Rights are essentially call options, issued to the existing shareholders. Today, shareholders exercise these options, let them expire worthless or surrender/transact them in OTC market. Listing and trading of rights on Stock Exchanges would help the shareholders monetize their options much more efficiently (better liquidity, price discovery and ease). Opportunity: Credit rights entitlements (REs) to shareholders in their Demat account. List and trade the REs on Stock Exchanges.

13. 13. Put options & buy back – An opportunity Fixed price buy back of shares is essentially a put option, offered by companies to the existing shareholders. Today, shareholders exercise these options or let them expire worthless. There is no market to transact these options. Based on exercise or no exercise, process results in non-homogeneous distribution of values among investors. Listing and trading of these options on Stock Exchanges would help the shareholders monetize their option. Opportunity: Credit buy back entitlements (BEs) to shareholders in their Demat account. List and trade the BEs on Stock Exchanges. Companies may also write put warrants to the market participants (builds confidence + earns money).

14. 14. Third party Warrants – An opportunity A warrant is nothing but an option - may be call or put. Institutions may write call options backed by the shares, they own (covered call). Institutions may like to buy the put options on the shares, they own. Institutions may also write long dated naked options. In this case, their positions may be margined like any other sold position (institution created product and not the exchange created product). Warrants may be cash settled or physically settled warrants.

15. 15. Derivatives Risk Management in OTC OTM market has a lot to learn from the exchange environment on risk management. More and more business to move to collateralized basis: – Margining to make customers much more disciplined – Margining avoids unhealthy competition among intermediaries – Margining results in reduction in credit risk and capital charge, which in turn reduces the threshold minimum return on the trades i.e. Pricing, hopefully, becomes sharper (better for customers) – Regulators may like to define minimum margin for all OTC trades – Opportunity for clearing corporations to take up/serve the OTC trades

16. 16. Derivatives Risk Management in OTC OTC market will eventually outsource credit risk management function to professional entities (clearing corporations): – Significant focus on monitoring and control of credit limits. – Efficient execution of collateral agreement in timely manner - MTM computation, collateral calls and squaring off of transactions Clearing corporations to build competencies /gear up to handle complicated/structured transactions in the OTC world (beginning may happen with simple transactions). CCIL has already taken several steps in this direction. Journey is still a very lengthy one.

17. 17. Become a learning machine. Charlie Munger Concluding remark

18. Thank you Please feel free to reach me at Manish.bansal@jeetay.com +91 98924 86751