Risk Management of Derivatives

in Bombay Stock Exchange

Limited.

Presented By
Dillip Khuntia
 Risk is a Part of God’s
Game,
Alike for Man and
Warren Nation
Buffett……………
 Content
Introduction
Company Profile
Conceptual Study

Analysis and Interpretation of Data

Findings
Recommendations

Conclusion
 Introduction
 Objective of the
Study
 Research
Methodology
 Limitation of Study
 Objective of the Study

To Study the Risk associated with Derivatives

Market and it’s Trading.
To Study the Risk Management Tools used in
Bombay Stock Exchange Limited for Mitigating
these Risks.
To Study the Margining System and IT
Application for Derivatives.
 Contd……….

To Make a Comparative Analysis of the Risk

Management Process of Bombay Stock Exchange
Limited with that of National Stock Exchange
Limited, and,
To give Policy Suggestions and Recommendations
for Improvement in Risk Management Process of
Derivatives in Bombay Stock Exchange Limited.
 Research Methodology

Scope
Time Frame
Data Sources
 Limitation of Study
Information Constraint

Time Constraint
 Company Profile
Established as “The Native Share
& Stock Brokers Association” in
1875.
Got Permanent Recognition in
1956 from Government of India
under the Securities Contracts
(Regulation) Act, 1956.
Got the Status of a Company in
2005 under Companies Act, 1956.
Nation – wide reach.
BOLT.
 Conceptual Study
A Derivative is a Financial Contract whose
Value is Derived from the Value of an
Underlying Asset.
 Emergence of Derivatives
◦ Bible, Genesis Chapter 29. (Jacob, Laban,
Rachel)
◦ First Exchange Traded Derivative: Royal
Exchange, London. Forward Contracts on
Tulip Bulbs, 1637.
◦ First Futures Contract: Yodaya Rice Market
in Osaka, Japan, 1650.
◦ CBOT, 1848.
◦ 1865, CBOT, First Futures Contract.
◦1919, Chicago Butter and Egg Board.
(CME)
◦1925, First Clearinghouse for Futures
◦ 1970’s, Modern Derivatives Market
◦ Unprecedented Volatility,
◦ Breakdown of Brettonwood System
◦ Next Fillip, Interest Deregulation, 1979
◦ Oil Shock, 1980’s
◦ Balance of Payment Situation.
 Derivative Products
Forwards
Futures
Options
Warrants
LEAPS
Baskets
Swaps
SOURCES: Dow Jones
Types of Derivatives
 Business Growth of Derivatives in India from
2000- 2011(May)
Indian Derivatives Market
20000000
18000000
16000000
14000000
12000000
10000000
8000000
6000000
4000000
2000000
0
-01 -02 -03 -04 -05 -06 -07 -08 -09 -10 -11
000 001 002 003 004 005 006 007 008 009 010
2 2 2 2 2 2 2 2 2 2 2

Indian Derivatives Market

Average Daily Turnover of India’s Derivatives
Market
Average Daily Turnover
100000
90000
80000
70000
60000
50000
40000
30000
20000
10000
0
-01 -02 -03 -04 -05 -06 -07 -08 -09 -10 -11
000 001 002 003 004 005 006 007 008 009 010
2 2 2 2 2 2 2 2 2 2 2

Average Daily Turnover

 Risk & Risk Management
 Uncertainty of Outcome.

 Common & Inherent in Financial Markets.

 Risk Management: Identification, Assessment, and

Prioritization of Risk .
 Followed by Coordinated and Economical Application
of Resources to Minimize, Monitor, and Control it.
 Risk Associated With Derivatives

Price Risk

Default Risk

Systemic Risk
Risk Management of Derivatives
 Margins

 Mark-to-Market of Margin

 Exposure Limits

 Position Limits

 Final Settlement
 Margin & Margining System
Up-front Payment of Cash or Cash
Equivalents.
To Ensure the Performance of the
Obligation.
Two Types of Margining
» Strategy – Based Margining
System
» SPAN Margining System.
 The SPAN Margining System

SPAN: - Standard Portfolio Analysis of

Risk
Inputs of SPAN,
» The Future’s Price Scan Range
» The Implied Volatility Scan
Range
» The Minimum Short Option
Charge
» The Calendar Spread Charge
 Margins for Equity Derivatives in
Indian Market
• Initial Margin, based on Worst – loss case of the Portfolio.
• Initial Margin Requirement
» For Index Products: - 3σ
» For Stock Products: - 3.5σ
• Minimum Margin Requirement
» For Stock Futures & Options: - 7.5% of
Notional Value of the Contract.
» Index Futures: - 5% of Notional Value of the
Contract.
» Index Option: - 3% of Notional Value of the
Contract.
SOURCE: J.R. Verma Committee Report & SEBI Master’s Circular
 Exposure Limits
For Stock Futures
» The Notional Value of Gross
Open Positions Should not
Exceed 20 Times of the available
Liquid-Net-Worth, i.e. 10% or
1.5σ of the Notional Value of
Gross Open Position, whichever
is Higher.
SOURCE: J.R. Verma Committee Report & SEBI Master’s Circular
For Stock Options
» The Notional Value of Gross Open
Positions Should not Exceed 20 Times of
the available Liquid-Net-Worth, i.e. 5%
or 1.5σ of the Notional Value of Gross
Open Position, whichever is Higher.
For Index Products
» The Notional Value of Gross Open
Positions Should not Exceed 33 1/3
Times of the available Liquid-Net-
Worth.
SOURCE: J.R. Verma Committee Report & SEBI Master’s Circular
 Position Limits
Market Wide Limit on the open position on Stock options
& Futures is 20% of Free Float.
For Stock Options & Futures, Stock having a MWPL of
500 crores or more, Position Limit is 20% of MWPL or 300
crores, whichever is Lower. (Applicable to TB, FII, MF)
For index Futures & Options, the TB, FII, & MF Position
Limit: Higher of 500 crores or 15% of the total Open
Interest in Equity Index Futures or Options Contracts,
respectively
SOURCE: J.R. Verma Committee Report & SEBI Master’s Circular
 Contd……….
The Gross Open Position of Clients, Sub-accounts, NRI &
for Each Scheme of MFs across all Derivatives Segment
shall not Exceed Higher of; 1% of Free Float Capitalization
or 5% of the Open Interest in underlying Stock.
Any Person holding more than 15% Open Interest in all
types of Derivatives contract shall be required to Disclose it
to the Exchange.

SOURCE: J.R. Verma Committee Report & SEBI Master’s Circular

 Final Settlement
• On Expiry, Settlement in Cash.
• Settlement Price: Closing Price of the
Underlying
• Profit or Loss is Paid in/out in T+1 day.
• On Expiry if Options are not exercised or
Closed out, all In-the-money are Settled by
the Exchange.
• On Exercise, the Settlement takes place on
T+1 Day and in Cash.
• The Assignment takes place on a Random
Findings
 Margins & Margining System
BSE uses SPAN Margining System.
SPAN Covers 99% VaR on a Real Time Basis.
SPAN: An Integrated System of Margin
Calculation.
PC SPAN : Software for SPAN Margin
Calculation.
Developed By CME.
Provides Adequate
Information.
Reliable
Most Efficient Software
Risk Management in BSE
Effective and Efficient Risk Management Process.
Sometimes Collects More Margin for Better Risk
Management.
Helps in increasing Market Integration.
On Comparison, BSE and NSE follow the same Process of
Risk Management.
NSE Provides more Reliable Data as compared to BSE.
NSE has better Risk Monitoring System, which BSE
Lacks.
 Suggestions
• BSE should try to Provide Integrated Service.
• BSE should Provide Data on a Real Time Basis and in
Tabular Format rather than Graphical Format.
• BSE has to Constantly Innovate to Improve its Market
Position in Derivatives segment.
• BSE Should Adopt Better Risk Monitoring System.
• Reasonable Margin should be Collected.