Derivatives have widely been used as they facilitate hedging, that is, they enable fund mangers of an underlying asset portfolio to transfer some parts of the risk of price changes to others who are willing to bear such risk. Options are the specific derivative instruments that give their owner the right to buy (call option holder) or to sell (put option holder) a specific number of shares (assets) at a specified price (exercise price) of a given underlying asset at or before a specified date (expiration date). In lieu of this privilege, the holder of the option (long position) pays a market determined price (option premium) to the writer or seller (short position) of the option.
The present study has used buy-and-hold strategies involving future & options and a combination their-off, like Covered Call, Straddle and Strangle .In an attempt to make appropriate investment decisions in particular under risk the portfolio manager must be able to compare the hedging effectiveness of the strategies involving the use of options under covered call and the pure option strategies like straddle and strangle. The study also examines the risk and return associated to taking of future position as buy-and-hold strategy vis-à-vis cash position.
The Indian equity market has widely been regarded as one of the best performing market amongst the emerging markets of the world like China, Indonesia, Brazil, Russia, Mexico, Korea etc. The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws (Amendment) Ordinance, 1995. It withdrew the prohibition on options in securities. SEBI set up a 24 -member committee under the Chairmanship of Dr. L. C. Gupta on November 18, 1996 to develop regulatory framework for derivatives trading in India. In its report, the committee prescribed necessary pre-conditions for introduction of derivatives trading in India; it recommended that derivatives should be declared as 'securities' so that the regulatory framework applicable to trading of 'securities' could also govern trading of securities.
SEBI also set up a group in June 1998 under the Chairmanship of Prof. J. R. Varma to recommend measures for risk containment in derivatives market. The Report worked out the operational details of margining system, methodology for charging initial margins, broker net worth, deposit requirement and real-time monitoring requirements.
Derivatives trading commenced in India after SEBI granted the final approval to commence trading and settlement in approved derivative contracts on the NSE and BSE.This has also been proved beyond doubt across the financial world that the regulatory norms in place governing the Indian Capital Market are one of the best in the world. Recently NSE has been awarded "Derivative Exchange of the year" by Asia Risk Magazine.
Objectives of the Project
- To examine the performance of various derivatives based investment strategies.
- To examine the risk associated with different investment strategies
- To examine whether derivatives can be used as an alternative to cash market investing.
Scope of study
- This study helps to improve investment activities in securities.
- It helps to give ideas about derivatives to students.
- New strategies can be identified by the people who actively invest in derivatives.
- Out of the money call and in the money put only selected to apply the strategies. It may be further analysed in different dimensions. Some popular strategies only taken in to analysis, it has a wide scope to add other derivatives based strategies.
- The boundary of the study is that the collection of data is limited to a specific time period Jan-2007 to march-2007.
The results of the derivative based portfolio on S&P CNX Nifty Index future and the cash portfolio of the corresponding index shown that during the entire 60 months beginning 1 st Jan 2004 under study, the derivative portfolio based of S&P CNX Nifty Index future does not at all amount in higher degree of risk when compared with the cash portfolio being held in proportion to the index composition, rather compensates very smartly for higher degree of risk under taken by the investors.
The results of the derivative portfolio (covered call on S&P CNX Nifty Index) and the cash portfolio of the corresponding index indicate s that in terms of aggregate return, the cash portfolio has an edge over the derivative portfolio during the entire period of study, and in terms of risk compensation as point out by Sharpe's ratio, it is the cash portfolio that has an edge over derivative portfolio.
In terms of aggregate return the derivative portfolio strategy of Straddle have resulted in negative returns. Hence, in the present study, the proposed methodology of selecting the strike price of the straddle only on the basis of long term historical growth rate needs to be revisited, as it does not provide any evidence to support such strategy for rational investors either in terms of risk, return or combination thereof.
In terms of aggregate return the derivative portfolio strategies of strip has resulted in negative returns. Hence, in the present study, the proposed methodology of selecting the strike price of the straddle only on the basis of long term historical growth rate needs to be revisited, as it does not provide any evidence to support such strategy for rational investors either in terms of risk, return or combination thereof.
The through perusal of the tables shows that the Sharpe's ratio favours the strip only during January and June. Hence, results advocate that there is no use of going in for the options based strategy called strap.
In case of long strangle, the entire initial capital has been lost, where as in case of short Strangle capital have been increased by more than three times. The Sharpe ratio has been higher during the entire period under study in case of short as well as long strangle.
It has been found that in the case of option based strategy called Bear spread, its performance has shown some positive compared to other derivatives strategies. In case of Bear Spread, Capital has been increased by more than 30%. The Sharpe ratio has been average during the entire period under study in case of Bear Spread.
In case of Bull Spread, Capital has been decreased by more than 23%. The Sharpe ratio has been lower during the entire period under study in case of Bear Spread. In case of Bear Spread, Capital has been increased by more than 30%. The Sharpe ratio has been average during the entire period under study in case of Bear Spread. Here, Capital has been increased by more than 4%.
Indian security Market Review 2008, by NSE, India.