Professional Assessment in Integrity Matters (Specialist)

Correct: By entering into a pay-fixed, receive-floating interest rate swap, the firm pays a predetermined fixed rate to the swap counterparty and receives a floating rate (MIBOR). The floating rate received from the swap is used to service the floating rate interest on the original loan. This effectively locks in the interest expense at the fixed swap rate plus the original loan spread, neutralizing the risk of rising MIBOR rates in line with RBI’s permitted hedging practices.

Incorrect: Choosing to receive a fixed rate while paying a floating rate would exacerbate the firm’s risk because the firm would be paying floating rates on both the loan and the swap as MIBOR rises. The strategy of using a basis swap only switches one floating benchmark for another, which does not eliminate the risk of an overall increase in interest rates across the yield curve. Opting for an interest rate floor is a strategy used to protect against falling interest rates, which contradicts the treasurer’s objective of hedging against rising borrowing costs.

Takeaway: A pay-fixed interest rate swap effectively hedges against rising interest rates by converting floating-rate debt into a fixed-rate obligation.

Correct: Risk-neutral valuation is a fundamental pricing principle which states that the value of a derivative is independent of the risk preferences of investors. By assuming a risk-neutral world, the expected return on the underlying asset becomes the risk-free rate. This approach is valid because the price of a derivative is determined by the requirement that no-arbitrage opportunities exist, meaning the risk-neutral price must also be the correct price in a risk-averse world.

Incorrect: Relying on the idea that SEBI mandates a specific valuation model based on historical volatility is incorrect, as regulators generally focus on risk management frameworks rather than prescribing specific mathematical pricing theories. The strategy of including subjective risk premiums contradicts the objective nature of no-arbitrage pricing, which seeks a single fair value regardless of individual risk appetites. Focusing only on the simplification of Greeks like Delta and Gamma misrepresents the purpose of the model, as risk-neutral valuation is about the fundamental discounting of expected payoffs rather than just sensitivity analysis.

Takeaway: Risk-neutral valuation enables derivative pricing using the risk-free rate, ensuring the resulting price is consistent with no-arbitrage principles.

Correct: In the Indian derivatives market, exchange-traded futures are characterized by a daily mark-to-market (MTM) process. This means that at the end of each trading day, the clearing corporation calculates the difference between the previous day’s settlement price and the current day’s price, adjusting the margin accounts of the participants accordingly to prevent the buildup of large unrealized losses.

Incorrect: The strategy of customizing contract specifications is a hallmark of forward contracts, whereas futures on the NSE are standardized by the exchange regarding lot size and expiry dates. Relying on bilateral credit agreements is common in the OTC market, but exchange-traded futures use a central counterparty to eliminate individual credit risk. Opting for physical delivery is incorrect for index products in India, as equity index futures are mandatorily cash-settled rather than requiring the transfer of underlying shares.

Takeaway: Exchange-traded futures in India are standardized, cash-settled instruments featuring daily mark-to-market settlement through a central clearing corporation.

Correct: Under the RBI guidelines for Credit Default Swaps, protection buyers are required to have an underlying exposure to the credit risk they are hedging. This ensures that the derivative is used for risk management purposes. Furthermore, the notional amount of the CDS contract is capped at the face value of the underlying debt instrument to prevent speculative over-leveraging.

Incorrect: The strategy of limiting settlement to physical delivery is incorrect because RBI regulations allow for both physical and cash settlement methods. Opting for retail individuals as market-makers is prohibited as only regulated entities like banks, primary dealers, and certain NBFCs can serve in that capacity. Focusing only on sovereign debt as the reference entity is a misconception because the Indian CDS framework is specifically designed to support the corporate bond market and includes various corporate debt instruments.

Takeaway: In India, CDS protection buyers must hold an underlying exposure to the reference entity as per RBI risk management guidelines.

Correct: In the Indian financial markets, a Rupee Interest Rate Swap (IRS) is a symmetric contract where both parties are obligated to exchange interest rate cash flows, effectively fixing the interest cost at inception without an upfront premium. In contrast, an Interest Rate Cap is an option-based derivative (asymmetric) that protects the buyer from rates rising above a strike level while allowing them to benefit if MIBOR falls, which requires the payment of an upfront premium to the seller.

Incorrect: The strategy of treating swaps as premium-based instruments is incorrect because swaps are typically entered at a zero net present value without upfront fees. Claiming that swaps are only exchange-traded ignores the significant over-the-counter (OTC) market regulated by the Reserve Bank of India (RBI). Describing a swap as a tool to benefit from falling rates while being protected from increases is a fundamental misunderstanding, as swaps lock in a fixed rate and remove the benefit of lower market rates. Relying on the idea that caps are only insurance products misidentifies the regulatory framework, as interest rate derivatives are primarily governed by RBI directions for scheduled commercial banks and standalone primary dealers.

Takeaway: Swaps provide cost certainty through symmetric obligations, while caps offer flexible protection through asymmetric, premium-based option structures.

Correct: In the Indian financial system, forward contracts are Over-the-Counter (OTC) instruments negotiated directly between a client and a bank, allowing for complete customization of the contract size and the specific maturity date to match business needs. In contrast, futures contracts traded on exchanges like the NSE or BSE are standardized by the exchange regarding lot sizes and expiration dates, which may not perfectly align with a specific bespoke date required by a corporate hedger.

Incorrect: The strategy of treating futures as private bilateral agreements is incorrect because futures are exchange-traded and subject to clearing house guarantees and margin requirements. Simply conducting forward trades on the NSE is a misunderstanding of market structure, as forwards are OTC products while futures are the exchange-traded equivalent. The suggestion that forwards are strictly cash-settled by SEBI mandate ignores that forwards often result in the actual delivery of currency through the banking system. Focusing on upfront premiums for futures is a conceptual error, as premiums are characteristic of options, whereas futures involve initial and maintenance margins rather than a non-refundable cost.

Takeaway: Forward contracts offer customization for specific dates and amounts OTC, while futures provide standardized, exchange-traded liquidity with daily mark-to-market settlement.

Correct: In a standard CDS transaction under RBI guidelines, the protection buyer transfers the credit risk of a reference entity to a protection seller. This is achieved by paying a fixed periodic fee, known as a premium, in exchange for a contingent payment triggered by specific credit events such as bankruptcy, insolvency, or failure to pay. This allows the bank to hedge its exposure without selling the underlying bond.

Incorrect: The strategy of transferring legal title of the underlying bonds is incorrect because a CDS is a synthetic derivative designed to transfer risk while the asset remains on the buyer’s balance sheet. Requiring the full notional value to be held in escrow by SEBI is a misunderstanding of capital efficiency and margin requirements in the Indian OTC derivative markets. Focusing only on total loss for all senior creditors is inaccurate because credit events are defined by specific triggers like restructuring or failure to pay, which do not necessarily require a total loss of all principal.

Takeaway: Credit Default Swaps allow Indian institutions to transfer credit risk to a seller through periodic premiums without liquidating the underlying asset.

Correct: The principle of risk-neutral valuation is derived from no-arbitrage pricing. If a derivative can be perfectly hedged using the underlying asset (like NIFTY 50 futures or stocks) and a risk-free instrument, the resulting portfolio is riskless. In an efficient market, any riskless portfolio must earn the risk-free rate. Therefore, we can price the derivative by assuming the world is risk-neutral, as the actual risk preferences of investors do not affect the price once the arbitrage-free relationship is established.

Incorrect: Suggesting that SEBI mandates a specific assumption of market risk-neutrality for reporting purposes confuses regulatory compliance with mathematical finance theory. Describing the methodology as a simplified accounting convention due to estimation difficulties ignores the fundamental role of replicating portfolios in modern pricing. Claiming the assumption requires a linear growth path for the index is a technical error, as risk-neutral valuation specifically accounts for the stochastic volatility and random walks inherent in equity markets.

Takeaway: Risk-neutral valuation allows derivative pricing based on no-arbitrage and replicating portfolios rather than subjective risk preferences.

Correct: The no-arbitrage pricing principle, fundamental to Indian derivative markets regulated by SEBI, states that the price of a derivative is determined by the cost of replicating its payoffs. If the futures price deviates from the spot price plus the cost of carry, an arbitrageur could lock in a risk-free profit by simultaneously trading in the cash and derivatives segments, which would quickly force the prices back into equilibrium.

Incorrect: The strategy of basing prices solely on market sentiment or expected future spot prices describes the expectations hypothesis, which does not account for the cost of carry or replication. Relying on the idea that an exchange clearing corporation fixes prices is incorrect, as prices are discovered through market mechanisms within the no-arbitrage bounds. Opting for the view that futures must always trade at a discount ignores the impact of interest rates and dividends, which typically result in futures trading at a premium in the Indian context.

Takeaway: No-arbitrage pricing links derivative values to the underlying spot price and financing costs to prevent risk-free profit opportunities in the market.

Correct: A Credit-Linked Note (CLN) is a funded credit derivative. Unlike an unfunded Credit Default Swap (CDS), the investor pays the principal amount upfront to the issuer. Consequently, the investor faces ‘dual’ credit risk: the risk that the reference entity (the infrastructure company) suffers a credit event, and the risk that the issuer (the bank) defaults on its obligation to return the principal or pay interest. If either entity fails, the investor’s capital is at risk.

Incorrect: The strategy of assuming principal is ring-fenced in an escrow account is incorrect because CLNs are typically balance-sheet obligations of the issuer. Relying on the clearing corporation to mitigate reference entity risk is a misunderstanding of structured products, as these are often bilateral contracts rather than exchange-cleared instruments. The assumption that the Reserve Bank of India provides a guarantee for settlement is false, as regulatory oversight does not equate to a sovereign guarantee of private financial instruments.

Takeaway: Investors in Credit-Linked Notes must perform due diligence on both the reference entity and the instrument’s issuer due to dual credit exposure.

Correct: An equity swap allows the manager to receive the total return of a specific equity index, including dividends and capital gains, while paying a floating rate like the Mumbai Interbank Offered Rate (MIBOR). This over-the-counter derivative is ideal for institutional investors seeking precise exposure over a fixed term without the tracking error associated with rolling exchange-traded futures or the operational costs of physical replication.

Incorrect: The strategy of rolling monthly futures contracts on the National Stock Exchange is suboptimal because it incurs significant transaction costs and roll risk, which increases tracking error over a two-year period. Choosing to purchase a strip of call options is an inefficient replication method as it requires a large upfront premium and only provides exposure to the upside, failing to capture the full performance profile. Focusing on structured products with knock-out barriers introduces unnecessary complexity and the risk that the exposure could be terminated prematurely if the barrier is breached.

Takeaway: Equity swaps enable institutional investors to achieve precise, total return equity exposure with minimal tracking error compared to rolling futures.

Correct: In a CDO structure, credit enhancement for senior tranches is achieved through subordination. This is managed via a waterfall mechanism where cash flows are distributed in order of seniority, and losses are absorbed from the bottom up. The equity or junior tranches act as a buffer, taking the first hit from defaults in the underlying bond pool, thereby protecting the senior investors as per standard securitization practices in India.

Incorrect: The strategy of seeking a sovereign guarantee from the Reserve Bank of India is incorrect because the central bank does not provide credit guarantees for private securitization instruments. Opting for an equal distribution of payments across all tranches describes a pass-through structure rather than a tranched CDO and fails to provide the necessary credit enhancement for senior layers. Focusing only on zero-coupon government bonds as underlying assets is impractical for a CDO, as these instruments are already risk-free and do not require the complex credit structuring or tranching that CDOs are designed to provide for credit-risky corporate assets.

Takeaway: CDOs utilize tranching and subordination through a waterfall structure to redistribute credit risk from senior to junior investors.

Correct: Under SEBI guidelines, mutual funds are permitted to use exchange-traded equity derivatives for hedging and portfolio rebalancing. A protective put strategy, which involves buying put options on stocks already held in the portfolio, is a recognized hedging technique that limits downside risk while maintaining the potential for upside gains, provided the total exposure stays within the regulatory limits defined by SEBI.

Incorrect: Writing uncovered call options is typically restricted for mutual funds because it exposes the fund to theoretically unlimited risk, which contradicts the objective of prudent risk management. Opting for over-the-counter (OTC) equity options is generally not permitted for mutual funds as SEBI requires these transactions to be conducted on recognized stock exchanges like the NSE or BSE to ensure transparency and clearing house guarantees. The strategy of selling put options to fund call options actually increases the fund’s market exposure and downside risk, failing to provide the intended hedge against a market correction.

Takeaway: SEBI-registered mutual funds primarily use exchange-traded put options to hedge downside risk within prescribed gross exposure limits.

Correct: In a Forward Rate Agreement, the contract is cash-settled. The settlement occurs at the beginning of the contract period (the settlement date). Because the payment is made at the start of the period rather than the end, the difference between the reference rate and the FRA rate is calculated on the notional principal and then discounted to its present value using the reference rate.

Incorrect: The strategy of paying the total interest at the end of the loan term is incorrect because FRAs are settled at the start of the interest period, not the end. Relying on a physical loan delivery is a misconception, as an FRA is a derivative instrument used for hedging and does not involve the actual lending of funds. Choosing to exchange the full notional principal is an error that confuses an interest rate derivative with a principal-based contract like a currency swap; FRAs never involve the exchange of principal.

Takeaway: Forward Rate Agreements are cash-settled derivatives where the net interest differential is paid on a discounted basis at the settlement date.

Correct: An Interest Rate Cap consists of a series of European-style call options on a reference rate like MIBOR. It provides the buyer with protection against rising interest rates by paying the difference when the reference rate exceeds the strike price. This allows the borrower to effectively set a maximum interest rate while still benefiting from lower market rates if they remain below the strike level, as the option would simply expire unexercised.

Incorrect: The strategy of entering into a pay-fixed interest rate swap effectively locks in a specific interest rate, which removes the risk of rising rates but also prevents the firm from benefiting if MIBOR decreases. Purchasing an interest rate floor is an inappropriate hedge for a borrower because it provides a payoff when rates fall, which is typically used by lenders to protect their income. Opting to sell a receiver swaption generates premium income but creates a potential obligation to enter a swap at a disadvantageous rate if the counterparty exercises the option, failing to provide a reliable ceiling for the firm’s borrowing costs.

Takeaway: An interest rate cap provides a maximum interest rate limit for borrowers while maintaining participation in favorable downward rate movements.

Correct: Forward contracts in India are primarily over-the-counter (OTC) instruments. They are private agreements between two parties, such as a corporate entity and a bank, allowing for full customization of the contract size and maturity date. Because they are not cleared through a central counterparty like exchange-traded futures, they carry bilateral counterparty credit risk, meaning each party depends on the other to fulfill the obligation at maturity.

Incorrect: The strategy of requiring daily variation margins and initial margins is a characteristic of exchange-traded futures rather than OTC forward contracts. Relying on the National Stock Exchange for liquidity is incorrect because forward contracts are illiquid, private agreements that are generally held until maturity. Focusing only on SEBI regulation is a mistake because OTC foreign exchange derivatives in India are primarily governed by the Reserve Bank of India (RBI) under the Foreign Exchange Management Act (FEMA). Choosing to view these as listed securities ignores their fundamental nature as private, non-standardized bilateral contracts.

Takeaway: Forward contracts are customized OTC derivatives characterized by bilateral credit risk and a lack of exchange-based liquidity.

Correct: Under the Reserve Bank of India (RBI) Master Direction on Market-making in OTC Derivatives, non-retail users must use derivatives for hedging purposes. Aligning the swap’s notional amount, maturity, and reset frequency with the underlying loan ensures that the floating rate received from the swap offsets the floating rate paid on the loan. This effectively converts the liability into a fixed-rate obligation, minimizing basis risk and fulfilling the regulatory requirement for a bona fide hedge.

Incorrect: The strategy of over-hedging by using a higher notional value is considered speculative and violates the fundamental RBI requirement that derivatives must be used to manage identified risks rather than for profit-seeking. Choosing an uncorrelated or volatile benchmark fails to provide an effective hedge because the movements in the swap would not offset the movements in the loan interest, leading to increased market risk. Opting for a currency conversion through a swap without underlying foreign exchange exposure is restricted under FEMA and RBI regulations to prevent unauthorized currency speculation and systemic risk.

Takeaway: Effective interest rate hedging in India requires aligning swap terms with underlying exposures to comply with RBI risk management guidelines.

Correct: The no-arbitrage principle is the foundation of modern derivative pricing because it links the derivative price to the cost of a replicating portfolio. This ensures that no risk-free profit can be made by simultaneously buying the derivative and selling the replicating portfolio.

Correct: Under SEBI regulations, Market Linked Debentures (MLDs) are essentially debt instruments where the payoff is linked to an index. The ‘capital protection’ is not an external guarantee or insurance; it is a corporate promise. Therefore, the primary risk to the principal is the credit risk of the issuer. If the issuing NBFC faces insolvency or a credit downgrade, the investor may lose their principal regardless of how the Nifty 50 Index performs.

Incorrect: Focusing only on the tracking error of derivatives ignores the fundamental nature of the product as a debt obligation of the issuer. Relying solely on historical volatility fails to account for the counterparty risk inherent in the issuer’s balance sheet. The strategy of emphasizing exchange-level trading suspensions overlooks the fact that capital protection is a contractual obligation of the issuer that exists independently of daily market liquidity or exchange operations.

Takeaway: Capital protection in Indian structured products is a credit-linked obligation of the issuer, not an absolute or third-party guarantee of principal safety.

Correct: SEBI regulations require that at least 50% of the liquid assets deposited by a clearing member must be in cash equivalents to ensure immediate liquidity during market stress.

Correct: Under the RBI Master Direction on Rupee Interest Rate Derivatives, market makers must ensure that non-retail users (like corporates) use derivatives for hedging purposes. The regulation emphasizes that the complexity of the derivative product must be commensurate with the user’s risk management objectives and their capacity to understand and manage the associated risks.

Incorrect: Relying on the idea that SEBI provides individual transaction approvals is incorrect because the RBI is the primary regulator for interest rate derivatives in India. The strategy of restricting all activities to exchange-traded platforms like the NSE is inaccurate as OTC markets are legally accessible to eligible corporate users under current frameworks. Opting to use these instruments for speculative premium income is a violation of the regulatory requirement that non-retail users should primarily utilize derivatives to hedge underlying exposures.

Takeaway: RBI regulations require that interest rate derivatives for non-retail users are primarily used for hedging and match the user’s risk profile.

Correct: Forward contracts in India are Over-the-Counter instruments providing flexibility in contract size and maturity to match specific commercial needs. Currency futures on the NSE are standardized and involve a daily mark-to-market process where gains or losses are settled through margin accounts.

Correct: SEBI and Indian stock exchanges mandate strict position limits at the client, trading member, and market-wide levels for index derivatives. These limits are designed to maintain market integrity, prevent price manipulation, and manage systemic risk by ensuring no single entity holds an oversized portion of the open interest.

Incorrect: The strategy of seeking physical delivery is incorrect because equity index futures in India are mandatorily cash-settled based on the closing price of the underlying index. Opting for customized contract terms is not possible for exchange-traded futures, as these instruments must follow standardized specifications set by the exchange and SEBI. Focusing only on a static margin ignores the mandatory daily mark-to-market (MTM) process required by Indian clearing corporations to mitigate counterparty credit risk through daily cash flows.

Takeaway: Market participants in India must strictly adhere to SEBI-mandated position limits and standardized exchange rules for cash-settled index futures.

Correct: In the Indian regulatory framework for OTC derivatives, Potential Future Exposure (PFE) is a critical component of Counterparty Credit Risk (CCR). It uses statistical modeling to predict the peak exposure the bank might face over the life of the derivative, ensuring capital adequacy against future market movements even if the current value is low.

Incorrect: Using only the current replacement cost is insufficient as it only addresses Current Exposure and ignores the ‘add-on’ factor required to cover potential future fluctuations in the underlying rates. Confusing credit risk measures with the credit spread used in valuation ignores the distinction between pricing adjustments like CVA and the measurement of exposure for capital purposes. Restricting the definition to CCIL-mandated collateral is incorrect because PFE is a risk measurement concept that applies to the inherent risk of the contract, regardless of whether it is centrally cleared or bilateral.

Takeaway: Potential Future Exposure measures the peak replacement cost a bank might face due to market volatility over a derivative’s remaining tenor.

Correct: In India, SEBI mandates a robust risk management framework where the Clearing Corporation acts as the central counterparty. This system requires the collection of Initial Margins using the SPAN (Standardized Portfolio Analysis of Risk) methodology to cover potential losses at a 99 percent confidence level. Additionally, Exposure Margins are collected to cover risks beyond the SPAN margin, and daily Mark-to-Market (MTM) settlement ensures that losses are realized and paid on a daily basis, preventing the buildup of systemic risk.

Incorrect: The strategy of using fixed-percentage margins is incorrect because SEBI requires risk-based margining that accounts for the specific volatility of the underlying asset. Relying solely on the net worth of the Trading Member is insufficient as it ignores the necessity of a central counterparty to guarantee settlement through novation. Choosing to allow sub-brokers to set their own collateral haircuts would lead to inconsistent risk standards and violates the requirement for standardized haircuts and centralized risk management overseen by SEBI-recognized Clearing Corporations.

Takeaway: India’s derivatives market relies on SPAN margins, exposure margins, and daily MTM settlement through a central counterparty to ensure financial integrity.

Correct: A Credit-Linked Note (CLN) is a structured product that embeds a credit default swap into a fixed-income security. In the Indian market, under RBI guidelines, the investor in a CLN takes on the credit risk of the reference entity (the infrastructure conglomerate) as well as the counterparty risk of the issuer (the bank). If either the issuer defaults or the reference entity experiences a defined credit event, the investor may lose part or all of their principal. This differs from a direct corporate bond, where the investor is only exposed to the credit risk of the bond issuer.

Incorrect: Relying on the assumption of principal protection from a regulatory fund is incorrect because CLNs are specifically designed to transfer credit risk to the investor, meaning the principal is explicitly at risk. Categorizing the instrument as an equity derivative linked to a broad market index like the NIFTY 50 is a misunderstanding of the product’s nature, as CLNs are credit derivatives focused on specific default events. Suggesting that a rating downgrade triggers physical delivery of bonds confuses the settlement mechanics of credit derivatives with the rights of a secured creditor or specific conversion features found in other hybrid instruments.

Takeaway: Credit-linked notes expose investors to the combined credit risk of the note issuer and the underlying reference entity.

Correct: The RBI Master Direction on Credit Derivatives distinguishes between market makers and users. Market makers, such as Scheduled Commercial Banks and Primary Dealers, are allowed to buy or sell credit protection without underlying exposure to facilitate market liquidity. In contrast, users are required to have an underlying exposure to the credit risk of the reference entity that they are seeking to hedge.

Incorrect: The approach of requiring all participants to have underlying exposure is incorrect because it fails to account for the specific role of market makers who provide liquidity to the Indian financial system. Claiming that CDS are exclusively exchange-traded ignores the robust framework for Over-the-Counter (OTC) transactions established by the RBI. Restricting the role of protection sellers only to insurance companies is inaccurate as the regulatory framework permits various financial institutions, including banks and standalone primary dealers, to act as market makers and sellers of protection.

Takeaway: RBI regulations allow market makers to trade CDS without underlying exposure, while requiring users to maintain exposure to the reference entity.

Correct: In the Indian derivatives market, futures contracts traded on exchanges like the NSE are subject to daily mark-to-market (MTM) settlement. This regulatory requirement ensures that the clearing corporation (NCL) calculates the difference between the trade price (or previous day’s settlement price) and the current day’s closing price at the end of every trading session. These gains or losses are settled in cash on a T+1 basis, meaning the client’s ledger reflects the loss immediately even if the position remains open.

Incorrect: The strategy of suggesting that liabilities are only settled weekly or based on margin failures ignores the mandatory daily cash flow requirement of exchange-traded futures in India. Proposing that funds are withheld for physical delivery of an index is incorrect because index futures are cash-settled and do not involve the delivery of individual stocks. Opting for the explanation that contracts convert into forwards due to circuit filters is a fundamental misunderstanding of how exchange-traded derivatives and price bands operate under SEBI guidelines.

Takeaway: Exchange-traded futures in India require daily mark-to-market settlement, where gains and losses are realized in cash every trading day.

Correct: Gamma is the second-order derivative of the option price with respect to the underlying asset’s price. It represents the rate at which the delta of a position changes. For a delta-neutral portfolio, gamma risk is the primary concern because a high gamma means the delta will shift significantly even with small movements in the underlying index. Managing gamma is crucial for institutional desks in India to ensure that a neutral hedge remains effective during volatile price swings or market gaps.

Incorrect: Focusing on Vega is incorrect because while volatility changes impact option pricing, Vega does not measure the stability of the delta-neutral hedge itself. Relying on Theta is a mistake in this context as it manages the impact of time passing rather than the directional risk arising from price shocks. Choosing to monitor Rho is inappropriate for this scenario because interest rate sensitivity is generally a minor factor for short-term equity index options compared to the immediate risk of price movements.

Takeaway: Gamma management is critical for maintaining delta-neutrality and controlling the risk of rapid directional exposure during large underlying price movements.

Correct: In the Indian equity derivatives market, stock options traded on the National Stock Exchange (NSE) are European-style, meaning they can only be exercised on the expiration date. A protective put strategy involves buying these put options to limit downside risk. Furthermore, SEBI mandates strict position limits at the client level (typically the higher of 1% of free float market capitalization or 5% of the open interest) to prevent market concentration and manipulation.

Incorrect: The strategy of writing uncovered calls is incorrect because it exposes the manager to unlimited upside risk and does not provide a floor against price declines. Relying on the assumption that margin requirements are waived is a regulatory misunderstanding, as SEBI requires mandatory initial and exposure margins for all market participants. Choosing American-style options is factually incorrect for the Indian context, as the NSE transitioned all stock options to a European-style exercise mechanism. Opting for bilateral off-exchange contracts to avoid reporting is a violation of SEBI regulations, which require standardized equity derivatives to be traded on recognized stock exchanges to ensure transparency and clearing house guarantees.

Takeaway: Indian equity options are European-style and require strict adherence to SEBI-mandated position limits and exchange-based reporting requirements.