Capital Markets – Practical problems

 GREEN SHOE OPTION:

 Green Shoe Option means an option of allocating shares in excess of the shares included
in the public issue and operating a post-listing price stabilizing mechanism in accordance
with the provisions of Regulations 57 & 153 of the SEBI (ICDR) Regulations, 2018.

 As per SEBI (ICDR) Regulations, 2018, the maximum number of shares that can be
borrowed by the stabilizing agent shall not be in excess of 15% of the issue size.

 Practical question can be under three situations:

Where the stabilising agent manages to buyback all of the Green

Situation 1
Shoe Shares.
Where all Green Shoe Shares are bought back: In this situation, funds in the Green
Shoe
Escrow Account (Rs.15,00,000, in this case) would be deployed by the stabilising agent
towards buying up shares from the open market. Given that the prices prevalent in the
market would be less than the issue price of Rs. 100, the stabilising agent would have
sufficient funds lying at his disposal to complete this operation. Having bought back all of
the 15,000 shares, these shares would be temporarily held in a special depository
account
with the depository participant (Green Shoe Demat Account), and would then be
returned back to the lender shareholders, within a maximum period of two days after
the stabilisation period.
Where the stabilising agent manages to buyback none of the Green
Situation 2
Shoe Shares.
Where none of the Green Shoe Shares are bought back: This situation would arise in
the (very unlikely) event that the share prices have fallen below the Issue Price, but the
stabilising agent is unable to find any sellers in the open market, or in an event where
the share prices continue to trade above the listing price, and therefore there is no need
for the stabilising agent to indulge in price stabilisation activities. In either of the above-
said situations, the stabilising agent is under a contractual obligation to return the 15,000
shares that had initially been borrowed from the lending shareholder(s). Towards
meeting this obligation, the issuer company would allot 15,000 shares to the stabilising
agent into the Green Shoe Demat Account (the consideration being the funds lying the
Green Shoe Escrow Account), and these shares would then be returned by the
stabilising agent to the lending shareholder(s), thereby squaring off his responsibilities.
Where the stabilising agent manages to buy-back some of the Green
Situation 3
Shoe Shares.
Where some of the Green Shoe Shares are bought back, say 10,000 shares: This
situation
could arise in an event where the share prices witness a drop in the initial stages of the
price stabilisation period, but recover towards the latter stages.
 In this situation, the stabilising agent has a responsibility to return 15,000 shares to the
lending shareholder(s), whereas the stabilising activities have yielded only 10,000
shares.
Similar to the instance mentioned in Situation #2 above, the issuer company would allot
the differential 5,000 shares into the Green Shoe Demat Account to cover up the
shortfall, and the Stabilising Agent would discharge his obligation to the lending
shareholder(s) by returning the 15,000 shares that had been borrowed from them.

Both in Situation #2 and #3, the issuer company would need to apply to the exchanges
for obtaining listing/ trading permissions for the incremental shares allotted by them,
pursuant to the Green Shoe mechanism.

Any surplus lying in the Green Shoe Escrow Account would then be transferred to the
Investor Protection and Education Fund established by SEBI, as required under
ICDR Regulations and the account shall be closed thereafter.

Q.1. Raman Ltd. issued 50 Lakh equity shares at a price of Rs.200 per share. The company
provided Green Shoe Option for stabilizing the post listing price of the shares. The issue
was oversubscribed and it was decided that stabilizing agent would borrow maximum
number of shares permitted by SEBI (ICDR) regulations. Due to rise in price during Green
Shoe Option period, only 5 Lakh shares could be bought back at the price of Rs.180. You
are required to:
(i) Calculate the number of shares that the stabilizing agent needs to borrow in this case at
the time of allotment and explain the same with relevant provisions.
(ii) Explain the responsibility of Issuer Company in the above case with respect to shortfall
while exercising Green Shoe Option.
(iii) Calculate the amount if any, to be transferred to Investor Protection and Education
Fund.
Solution:
Issue Size: 50 Lakhs equity shares
Issue Price: Rs.200 per share
Situation: Oversubscribed
Total share that can be borrowed by stabilizing agent – 15% of Issue size as per SEBI (ICDR),
2018
(i) Calculate the number of shares that the stabilizing agent needs to borrow in this case
at the time of allotment and explain the same with relevant provisions.

As per SEBI (ICDR) Regulations, 2018, the maximum number of shares that can be
borrowed by the stabilizing agent shall not be in excess of 15% of the issue size.

In the given case, stabilizing agent can borrow 7.5 Lakh shares (15% of 50 Lakh shares).
(ii) Explain the responsibility of Issuer Company in the above case with respect to
shortfall while exercising Green Shoe Option.

The issuer company would allot the differential 2.5 Lakhs shares into the Green Shoe Demat
Account to cover up the shortfall, and the Stabilising Agent would discharge his obligation to
the lending shareholder(s) by returning the 7.5 Lakhs shares that had been borrowed from
them.

The issuer company would need to apply to the exchanges for obtaining listing/ trading
permissions for the incremental shares allotted by them, pursuant to the Green Shoe
mechanism.
(7.5 – 5 = 2.5 lakhs shortfall)
(iii) Calculate the amount if any, to be transferred to Investor Protection and Education
Fund.

The Amount which should be transferred to Investor Protection and Education Fund will be
calculated as follows:

5 lakhs share bought back by stabilizing agent @ Rs.180/-

Issue Price – Rs.200/-
Surplus Amount: (Rs.200 – Rs.180) = 5,00,000 * 20 = Rs.1,00,00,000/-

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 FOREIGN CURRENCY CONVERTIBLE BONDS (FCCBS):

Suppose a company ‘A’ issues bonds with following terms:

Issue Price of the Bond Rs. 1000

Coupon rate 2%
Maturity 2 years
Convertible into equity shares @ Rs.800 per share

Now suppose an investor subscribes to 4 of these bonds. Thus the total investment is
Rs.4000.

On this investment, he is entitled to get an interest @ 2% for 2 years.

On the maturity date, i.e. after 2 years, the investor will have an option – to either claim full
redemption of the amount from the company or get the bonds converted into fully paid equity
shares @ Rs. 800 per share.
 Thus if he goes for the conversion he will be entitled to 5 (4000/800) equity shares.

The choice he makes will depend on the market price of the share on the date of conversion.

Situation 1: If the shares of the company ‘A’ is trading at lower than Rs.800, let’s say Rs.500, the
investor will be better off by claiming full redemption of his bonds and buying the
shares from the market. In this case, he will get 8 (4000/ 500) equity shares as
against 5 which he was getting on conversion.
Situation 2: Similarly if the market price of the share is higher than Rs. 800, the investor will
benefit by getting its shares converted. Thus, on the day of maturity, an investor will
seek full redemption if the conversion price is higher than the current market price,
and will go for conversion if the conversion price is less than the current market
price.

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 CALL and PUT Option:
Options Contract give its holder the right, but not the obligation, to take or make delivery on
or before a specified date at a stated price. But this option is given to only one party in the
transaction while the other party has an obligation to take or make delivery. Since the other
party has an obligation and a risk associated with making the good the obligation, he
receives a payment for that. This payment is called as option premium.
Option contracts are classified into two types on the basis of which party has the option:
a) Call option - A call option is with the buyer and gives the holder a right to take delivery.
b) Put option - The put option is with the seller and gives the right to take delivery.
Example: A investor purchases 1000 “Ray Technologies” Put at strike price of Rs.1070 and
Put price of Rs. 30/-. The investor pay Rs. 30,000 (30*1000) as Put premium.

The position of investor in two different scenarios have been discussed below:

1. May Spot price of Ray Technologies = Rs.1020

2. May Spot price of Ray Technologies = Rs.1080

In the first situation you have the right to sell 1000 “Ray Technologies” shares at Rs.1,070/-
the price of which is Rs. 1020/-. By exercising the option the investor earn Rs. (1070-1020)
=Rs.50 per Put, which amounts to Rs. 50,000/. The net income in this case is Rs. (50000-
30000) =Rs. 20,000.

In the second price situation, the price is more in the spot market, so the investor will not sell
at a lower price by exercising the Put. He will have to allow the Put option to expire
unexercised. In the process the investor only lose the premium paid which is Rs. 30,000.
 While buyer of an options has limited risk (Premium Amount), seller of an option has very
high rick (Market Price-Strike Price or Strike Price - Market Price), as the case may be,
depending on whether it is an call or put option.

Formulas:
 When you write a CALL option:
Profit/loss = [(Spot price – Strike price) + Premium.

 When you write a PUT option:

Profit/loss = [(Strike price – Spot price) + Premium.

 When you buy a CALL option:

Profit/loss = [(Strike price – Spot price) - Premium.

 When you buy a PUT option:

Profit/loss = [(Spot price – Strike price) - Premium.

Example 1 :
You are required to compute the profit/loss for each investors in below option contracts:
(i) Mr. X writes a call option to purchase share at an exercise price of Rs.60 for a premium of
Rs.12 per share. The share price rises to Rs.62 by the time the option expires.
Ans:
Situation - Writes a call option
Spot Price: Rs.60
Strike Price: Rs.62
Premium: Rs.12.

When you write a CALL option: Profit/loss = [(Spot price – Strike price) + Premium.
Profit/loss = [(60 – 62)+12]
= -2+12 = Rs.10 (Profit)

(ii) Mr. Y buys a put option at an exercise price of Rs.80 for a premium of Rs.8.50 per share. The
share price falls to Rs.60 by the time the option expires.
Situation – Buys a put option
Spot Price: Rs.80
Strike Price: Rs.60
Premium: Rs.8.50

When you buy a PUT option: [(Spot price – Strike price) - Premium.
Profit/loss = [(80 – 60) – 8.50
 = 20 - 8.50 = Rs.11.50 (Profit)

(iii) Mr. Z writes a put option at an exercise price of Rs.80 for a premium of Rs.11 per share. The
price of the share rises to Rs.96 by the time the option expires.

Situation – Writes a put option

Spot Price: Rs.80
Strike Price: Rs.96
Premium: Rs.11
When you write a PUT option: Profit/loss = [(Strike price – Spot price) + Premium.
The above situation the person can make profit of 96 - 80 = 16 from open market.
Hence, this put option will not be exercise to get premium of Rs.11.
(iv) Mr. XY writes a put option with an exercise price of Rs.70 for a premium of Rs.8 per share. The
price falls to Rs.48 by the time the option expires.

Situation – Writes a put option

Spot Price: Rs.70
Strike Price: Rs.48
Premium: Rs.8

When you write a PUT option: Profit/loss = [(Strike price – Spot price) + Premium.

Profit/loss = [(48 – 70) – 8

= -22 - 8 = Rs. – 14 (Loss)

Example 2 :
The Nifty Index was trading at 11025 on 1 st February, 2019 on NSE. The put option of 10800 with
expiry date of 28th February, 2019 was available at Rs.50 per lot and the call option of 11300 with
same expiry date was available at Rs.30 per lot. The size of one lot of Nifty is 75.
Ganesh who is regular trader in stock market purchased 2 lots of put options of 10800 and one
lot of call option of 11300.
On 22nd February, 2019, the Nifty Index was trading at 10850. Ganesh decided to square off all
these transactions. At the time of squaring off, the call option of 10800 could be sold at Rs.80 and
put option could be sold at Rs.5.
Calculate the Net gain/loss from this transaction considering the transaction charges including
brokerage is fixed at Rs.100 per lot (buy or sale).
Solution:
2 lots of PUT options of 10800
1 lot of CALL option of 11300
PUT Option calculation on 22.02.2019:
2 * 75 * 5 = 750
CALL Option calculation on 22.02.2019:
1 * 75 * 80 = 6000
TOTAL = 750 + 6000 = 6750 (Sell value) = A

COST OF OPTIONS:
PUT = 2 * 75 * 50 = 7500
CALL = 1 * 78 * 30 = 2250
TOTAL = 7500 + 2250 = 9750 (Cost) - B

Profit/Loss = (A-B) = 6750 – 9750 = Rs. -3000 (Loss)

Add: Transaction cost = (100 * 3) * 2 = 600
- 3000 – 600 = Rs.-3600/- (Net Loss)

Example 3:
Naman had executed following trades on Gama Ltd. stock:
(i) Purchased one 3-month call option with a premium of Rs.25 at an exercise price of Rs.530.
(ii) Purchased one 3-month put option with a premium of Rs.5 at an exercise price of Rs.430.
The lot size is 100 share per lot and the current price of Gama Ltd. stock is Rs.500.
Determine Naman’s profit or loss, if the price of Gama Ltd. stock after 3 months is :
(a) Rs.500
(b) Rs.350.
Solution:
(a) If price is Rs.500
 Total premium paid = (100*25) + (100*5) = Rs.3000/-
 When you buy a CALL option:
Profit/loss = [(Strike price – Spot price)
= (500 – 530) = -30 * 100 = -3000

 When you buy a PUT option:

Profit/loss = [(Spot price – Strike price)
= (430 – 500) = -70* 100 = -7000

In this case, Naman neither exercises the call option nor the put option, as both will result
in a loss for him.

(b) If price if Rs.350

Total premium paid = (100*25) + (100*5) = Rs.3000/-

 When you buy a CALL option:

Profit/loss = [(Strike price – Spot price)
= (350 – 530) = -180 * 100 = -18000
In this case, Naman would incur loss, hence no buy option to be exercised.

 When you buy a PUT option:

Profit/loss = [(Spot price – Strike price) - Premium
= (430 – 350) = 80 *100 = 8000
8000 – 3000 = Rs.5000/-

In this case, Naman would makes profit, hence put option to be exercised.

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 BOOK BUILDING PROCESS:
Number of shares issued by the Company = 100.

Price band = Rs. 30 – Rs. 40.

Bid Numbers of shares Cumulative demand Price per share (Rs.)

1 20 20 40
2 10 30 45
3 20 50 37
4 30 80 36
5 20 100 35
6 20 120 33
 7 20 140 30

The shares will be sold at the Bid 5 price of 20 shares for Rs.35.

Because Bidders 1 to 5 are willing to pay at least Rs. 35 per share. The total bids from
Bidders 1 to 5 ensure all 100 shares will be sold (20 + 10 + 20 + 30 + 20). The cut-off price is
therefore Bid 5’s price = Rs. 35. Bidders 1 to 5 get allotments at that price.

Bidders 6 and 7 don’t get an allotment because their bids are below the cut-off price.

Bidder 1 on allotment, the extra amount paid will be refunded to him. Since the cutoff price is
Rs. 35, the 20 shares will cost Rs. 700 (20 x Rs. 35).

The balance Rs. 100 (20*40 = 800) – (20*35=700) will be refunded to the investor.

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