• People invest money in the financial market with the hope of making good returns.

But the
investment may turn risky due to volatility in the prices of securities like commodities,
currency, equity, etc.

• During such fluctuations, all the predictions could go either way. This increases the
chances of wiping out your entire investments. Thus, the primary concern of the trader is
the risk that is associated with the financial market and flow of returns while trading in the
market.

• There are various instruments available that can protect a trader from the risks and
volatility of the financial markets. These instruments not only protect the traders but even
guarantees returns to them. Derivatives are such instruments. In fact, you will be surprised
to know about just the types of derivatives market that exist.
• The word ‘derivatives’ originated in mathematics and refers
to a variable that has been derived from another variable.
similarly a measure of temperature in Celsius could be
derived from a measure of temperature in Fahrenheit.

• In financial sense, a derivative is a financial product which

had been derived from a market for another product.

• Derivatives are financial contracts that derive their value

from an underlying asset. The value of the underlying asset
keeps on changing depending on the market conditions.
The derivatives can be traded by predicting the future price
movement of the underlying asset.
The underlying securities for derivatives :

• (a) Commodities (Castor seed, Grain, Coffee Beans, Pepper, Potatoes)

• (b) Precious Metals (Gold, Silver)
• (c) Short-term Debt Securities (Treasury Bills)
• (d) Interest Rate
• (e) Common Shares/Stock

• (f) Stock Index Value (NSE Nifty)

Derivatives are financial contracts whose value is linked to the value of an underlying asset.
They are complex financial instruments that are used for various purposes, including hedging
and getting access to additional assets or markets
• An asset is a resource owned or
controlled by an individual, corporation,
or government with the expectation that
it will generate a positive economic
benefit. Common types of assets include
current, non-current, physical, intangible,
operating, and non-operating. 
• Definition: “An asset is a resource
controlled by the enterprise as a
result of past events and from which
future economic benefits are
expected to flow to the enterprise.” Convertibility: Classifying assets based on how
• Cash and cash equivalents easy it is to convert them into cash.
• Accounts Receivable Physical Existence: Classifying assets based on
• Inventory their physical existence (in other words, tangible
• Investments vs. intangible assets).
• PPE (Property, Plant, and Equipment)
•
Usage: Classifying assets based on their business
Vehicles
• Furniture operation usage/purpose.
• Patents (intangible asset)
1. Current Assets
Classification of Assets: Usage
Current assets are assets that can be easily converted into cash and
If assets are classified based on their usage or purpose,
cash equivalents (typically within a year). Current assets are also
assets are classified as either operating assets or non-
termed liquid assets and examples of such are: Cash , Cash
operating assets.
equivalents , Short-term deposits , Accounts receivables ,
Inventory , Marketable securities , Office supplies
1. Operating Assets
Operating assets are assets that are required in the
2. Fixed or Non-Current Assets
daily operation of a business. In other words,
Non-current assets are assets that cannot be easily and readily
operating assets are used to generate revenue from a
converted into cash and cash equivalents. Non-current assets are
company’s core business activities. Examples of
also termed fixed assets, long-term assets, or hard assets. Examples
operating assets include:
of non-current or fixed assets include: Land , Building ,
Machinery , Equipment , Patents , Trademarks
Cash , Accounts receivable ,Inventory ,Building
,Machinery Equipment ,Patents ,Copyrights ,Goodwill
Classification of Assets: Physical Existence
1. Tangible Assets
2. Non-Operating Assets
Tangible assets are assets with physical existence (we can touch,
Non-operating assets are assets that are not required
feel, and see them). Examples of tangible assets include: Land ,
for daily business operations but can still generate
Building , Machinery, Equipment , Cash, Office supplies
revenue. Examples of non-operating assets include:
Inventory ,Marketable securities
2. Intangible Assets
Short-term investments ,Marketable securities , Vacant
Intangible assets are assets that lack physical existence. Examples of
land ,Interest income from a fixed deposit
intangible assets include: Goodwill , Patents , Brand ,Copyrights
,Trademarks Trade secrets ,Licenses and permits ,Corporate
intellectual property
Financial derivatives were originally developed as a means for companies to manage/hedge their risk.

• A good example that I like to use is Kellogg’s. Their performance is obviously very
sensitive to the price of corn.
• By using derivatives it allows them to guarantee a specific price for their corn at certain
dates in the future.
• This ensures that events such as bad weather or crop shortages has a minimal effect on
the business.
• It may be a good year for corn production and the oversupply may cause prices to drop
and Kellogg’s might lose out, having guaranteed a higher price.
• However for companies like this, it is more important to have a guaranteed future price,
than to make small gains trading the price of corn.
• Hedgers are those who try to minimize loses of both the parties entering into a derivative
contract. At the same time, they protect themselves against price changes in the products
that they deal in. They use options and futures and hedge in both financial derivatives and
commodities derivatives.
• 2. Speculators participate in futures and options. They take high risks for potential gains.
Their gains are unlimited but they can take positions and minimize their losses. They trade
mainly in futures. They are the major players of the derivatives market.
• 3. Arbitrageurs enter into two transactions into two different stock markets. They are able
to make a profit through the difference in price of the asset in different markets. They make
a risk less profit but they have to analyze the market with speed to ensure profitability.
 FUNCTIONS OF DERIVATIVES MARKET IN AN ECONOMY
A derivative is a financial instrument that derives its value from an underlying asset. The underlying asset can be
equity, currency, commodities, or interest rate. Thus, a change in the underlying asset leads to an equivalent
change in the derivative. Derivative markets are investment markets where derivative trading takes place.

Classification of derivatives
Derivatives can be broadly divided into two distinct groups:

Over the Counter (OTC): The OTC derivative market is the largest market for derivatives. Here, the derivatives are
traded privately without an exchange. Products such as swaps, exotic options, and forward rate agreements are
traded between highly sophisticated financial entities such as hedge funds and banks in private.

Exchange-traded derivative contracts (ETD): ETDs are derivative instruments that are traded in a derivatives
exchange. This exchange acts as an intermediary in all related transactions. As a guarantee, an initial margin is
submitted by both the buyer and the seller of the contract.
Risk management: The prices of derivatives are related to their underlying assets, as mentioned before. They can

thus be used to increase or decrease the risk of owning the asset. For example, you can reduce your risk by
buying a spot item and selling a futures contract or call option. This is how it works. IF there is a fall in the spot
price, the corresponding futures and options contract will also fall. You can repurchase the contract at a lower
price, which will result in a gain. This can partially offset the loss on the spot item.

Price discovery: Derivative market serves as an important source of information about prices. Prices of derivative
instruments such as futures and forwards can be used to determine what the market expects future spot prices
to be. In most cases, the information is accurate and reliable. Thus, the futures and forwards markets are
especially helpful in price discovery mechanism.

Operational advantages: Derivative markets have greater liquidity than the spot markets. The transactions costs
therefore, are lower. This means commissions and other costs for traders is lower in derivatives markets. Further,
unlike securities markets that discourage shorting, selling short is much easier in derivatives.
Therefore, by virtue of risk management, short selling, price discovery, and improved liquidity, derivatives make
the markets more efficient.
 CASH MARKET FUTURE MARKET
• A place where financial instruments are • Future market is a place where only future contracts are
traded, wherein the delivery of stock takes bought and sold at an agreed date in the future and at a
place. predefined price.
• When you buy shares and take delivery, you • You can never be a shareholder when you trade in
become shareholder of the company till you Futures.
hold the shares.
• Only margin money requires to be paid for initiating
• Full amount needs to be paid at the time of Future contract.
buying shares in cash.
• One has to buy a minimum lot size which is already
• One can buy even single share of company defined. Such as in case of NIFTY lot size is 75.
• In cash market you can buy shares and hold • In futures, you have to settle the contract on the
for life. expiration date i.e. maximum of three month.
• When you are shareholder of the company, • In future contract you are not entitle for any dividend.
you are entitled to receive dividend.
• Futures can be traded for Arbitrage, hedging or
• People buy shares in cash market for speculation purpose.
investment purpose.
Participants of Derivative Market
Hedgers: These are investors with a present or anticipated exposure to the underlying asset which is subject to
price risks. Hedgers use the derivatives markets primarily for price risk management of assets and portfolios.
Example: An importer has to pay US $ to buy goods and rupee is expected to fall to ` 50/$ from ` 48/$, then the
importer can minimize his losses by buying a currency future at ` 49/$.
Speculators: These are individuals who take a view on the future direction of the markets. They take a view
whether prices would rise or fall in future and accordingly buy or sell futures and options to try and make a
profit from the future price movements of the underlying asset.
Example: If you will the stock price of Reliance is expected to go up to ` 400 in 1 month, one can buy a 1 month
future of Reliance at ` 350 and make profits.
Arbitragers: These are the third important participants in the derivatives market. They take positions in financial
markets to earn risk less profits. The arbitragers take short and long positions in the same or different contracts
at the same time to create a position which can generate a risk less profit.
Example: A futures price is simply the current price plus the interest cost. If there is any change in the interest, it
presents an arbitrage opportunity.
• The term “Derivative” indicates that it has no independent value, i.e., its value is entirely derived from the
value of the underlying asset. The underlying asset can be securities, commodities, bullion currency, livestock.

• In other words, derivative means forward, futures, option or other hybrid contract of predetermined fixed
duration, linked for the purpose of contract fulfilment to the value of a specified real or financial asset or to
an index of securities.

• The underlying securities for derivatives are:

• (a) Commodities (Castor seed, Grain, Coffee Beans, Pepper, Potatoes)

• (b) Precious Metals (Gold, Silver)

• (c) Short-term Debt Securities (Treasury Bills)

• (d) Interest Rate

• (e) Common Shares/Stock

• (f) Stock Index Value (NSE Nifty)

Function of the Derivative Market
Detection of Prices: Prices in an organized derivatives market reflect the perception of the market participants about
the future and lead the prices of underlying to the perceived future level. The prices of derivatives converge with the
prices of the underlying at the expiration of the derivative contract. Thus derivatives help in discovery of future as well
as current prices.
Transfer of Risk: The derivatives market helps to transfer risks from those who have them but do not like them to
those who have an appetite for them.
Liquidity and Volume Trading: Third, derivatives due to their inherent nature are linked to the underlying cash
markets. With the introduction of derivatives, the underlying market witnesses higher trading volumes. This is
because of participation by more players who would not otherwise participate for lack of an arrangement to transfer
risk.
Encourages participating more people: An important incidental benefit that flows from derivatives trading is that it
acts as a catalyst for new entrepreneurial activity. They often energize others to create new businesses, new products
and new employment opportunities, the benefit of which are immense.
Derivative at BSE :The Derivatives Trading at BSE takes place through a fully automated screen-based trading
platform called Derivatives Trading and Settlement System (DTSS). Order Matching Rules Order Matching takes
place after order acceptance wherein the system searches for an opposite matching order. If a match is found, a
trade is generated. A unique trade-id is generated for each trade and the entire information of the trade is sent to
the relevant Members.

Order Conditions :The derivatives market is order driven i.e. the traders can place only orders in the system.
Following are the order types allowed for the derivative products.
Limit Order: An order for buying or selling at a limit price or better, if possible. Any unexecuted portion of the order
remains as a pending order till it is matched or its duration expires.
Market Order: An order for buying or selling at the best price prevailing in the market at the time of submission of
the order.
Stop Loss: An order that becomes a limit order only when the market trades at a specified price.
Order Retention Type (GFD/GTD/GTC):
Good For Day (GFD): The lifetime of the order is that trading session.
Good Till Date (GTD): The life of the order is till the number of days as specified by the Order
Retention Period. Good Till Cancelled (GTC): The order if not traded will remain in the system till it is
cancelled or the series expires, whichever is earlier.
Protection Points: This is a field relevant in Market Orders and Stop Loss orders. The value enterable
will be in absolute underlying points and specifies the band from the touchline price or the trigger price
within which the market order or the stop loss order respectively can be traded.
Risk Reducing Orders (Y/N): When a Member’s collateral falls below 50 lacs, he will be allowed to
put only risk reducing orders and will not be allowed to take any fresh positions. It is not essentially a
type of order but a mode into which the Member is put into when he violates his collateral limit.
Equity Derivatives?
Equity derivatives are financial products/instruments whose value is derived from the increase or decrease in the
underlying assets, i.e., equity stocks or shares in the secondary market.

• Equity derivatives are agreements between a buyer and a seller to either buy or sell the underlying asset in the
future at a specific price. They can either hold the right or the obligation to trade the asset at the expiry of the
contract.
• To trade an equity derivative, the investor needs to be very knowledgeable about the product and the industry,
as derivatives allow an investor to speculate and make large gains or losses. Investing in equity derivatives comes
with a number of risks, such as interest rate risk, currency risk, and commodity price risk.
 Products of Derivatives
Interest rate derivatives :
• Interest rate derivatives is interest rate swap. IT involves a bank agreeing to make payments to a counterparty
based on a floating rate in exchange for receiving fixed interest rate payments.
• It provides an extremely useful tool for banks to manage interest rate risk. Given that banks’ floating rate loans
are usually tied closely to the market interest rates while their interest payments to depositors are adjusted
less frequently. A decline in market interest rates would reduce their interest income but not their interest
payments on deposits

Commodity derivatives :
• commodities, driven by the problems about storage, delivery and seasonal patterns. But modern day
commodity derivatives markets only began to develop rapidly.
• The breakup of the market dominance of a few large commodity producers allowed price movements to
better reflect the market supply and demand conditions. The resulting price volatility in the spot markets
gave rise to demand of commodity traders for derivatives trading to hedge the associated price risks.
Foreign exchange derivatives :
• The increasing financial and trade integration across countries have led to a strong rise in demand for
protection against exchange rate movements over the past few decades.
• A very popular hedging tool is forward exchange contract. It is a binding obligation to buy or sell a
certain amount of foreign currency at a pre-agreed rate of exchange on a certain future date.
• Another type of foreign exchange derivatives are cross-currency swaps. This involves two parties
exchanging payments of principal (based on the spot rate at inception) and interest in different
currencies.
• According to many market participants, having a liquid cross-currency swap market is an important
for local currency bond market developments.
• This is because such instruments allow foreign borrowers in local bond markets to swap back their
proceeds to their own currencies while hedging against the interest rate risk.
A credit derivative is a contract in which a party (the credit protection seller) promises a payment to another (the
credit protection buyer) contingent upon the occurrence of a credit event with respect to a particular entity.
A credit event in general refers to an incident that affects the cash flows of a financial instrument . But in practice,
it could be filing for bankruptcy, failing to pay, debt repudiation or moratorium.
Credit derivatives over the past decade is credit default swap (CDS). In essence, it is an insurance policy that
protects the buyer against the loss of principal on a bond in case of a default by the issuer. The buyer of CDS pays
a periodic premium to the seller over the life of the contract. The premium reflects the buyer’s assessment of the
probability of default and the expected loss given default.
The two major types of markets in which derivatives are traded are namely:
• Exchange Traded Derivatives
• Over the Counter (OTC) derivatives
Exchange traded derivatives (ETD) are traded through central exchange with publicly visible prices.
Over the Counter (OTC) derivatives are traded between two parties (bilateral negotiation) without
going through an exchange or any other intermediaries. OTC is the term used to refer stocks that trade
via dealer network and not any centralized exchange. These are also known as unlisted stocks where
the securities are traded by broker-dealers through direct negotiations.  
• National Stock Exchange (NSE),
• Bombay Stock Exchange and
• Multi Commodity Exchange of India Ltd (MCX) or via over-the-counter market. 
Types Of OTC Derivatives
Over the counter trading can be of the following types on the basis of the following underlying assets:

1. Interest Rate Derivatives : Here, the underlying asset is a standard interest rate. Swaps, which
involve an exchange of cash flows, over a period of time, are an example of interest rate OTC
derivative trading.
2. Commodity Derivatives : Here, the underlying assets are physical commodities such as gold,
food grains etc. Forward contracts are an example of OTC trading in commodity derivatives.
3. Equity Derivatives : Here, the underlying assets are equities. Options and Futures are an example
of OTC trading in equity derivatives.
4. Forex Derivatives : The underlying assets are changes in foreign exchange rates.
5. Fixed Income Derivatives : Here, the underlying assets are fixed income securities.
6. Credit Derivatives : Here, one party transfers the credit risk to another without any exchange of
the underlying asset. Credit derivatives can either be funded or unfunded. Credit Default Swap (CDS)
and Credit Linked Notes (CLNs) are examples of OTC trading in credit derivatives.
Exchange Traded Derivatives The derivatives which are traded through stock exchanges are known as 
Exchange Traded Derivatives (ETDs), while those traded between two or more different parties - without the involvement of
stock exchanges or any other formal intermediary - are known as over the counter derivatives.
An Exchange Traded Derivative is standardized financial contract that is traded in stock exchanges in a regulated manner. They
are subject to the rules framed by market regulators such as the Securities and Exchange Board of India (SEBI) in India or
Securities . As compared to OTC derivatives, ETDs have certain advantages, like uniformity of rules and elimination of default
risks.
Index ETDs
These types of Exchange Traded Derivatives trade on the major stock indices. You can purchase or sell both index forwards and
index options. Some of the popular traded Index ETDs in India, and across the globe include:
• Nifty 50 The stock market index of the NSE, representing the weighted average of 50 of the largest companies listed on the
stock exchange.
• Sensex The stock market index of the BSE, representing the free-floating, market weighted average of the 30 well-established
companies listed on the exchange.
• Nikkei The stock market index of the Tokyo Stock Exchange, measuring the performance of the 225 largest, publicly listed
companies in Japan.
Differences Between Exchange Traded Derivatives and OTC derivatives.

Exchange Traded Derivatives (ETDs) Over The Counter Derivatives (OTDs)

The stock exchange facilitates bilateral This is a private transaction between two or
Nature of transaction
trading by acting as an intermediary. more parties.

Margin is according to the stock exchange The collateral is negotiated between the
Margin in trade
rules. parties.

Liquidation is subject to negotiation and

Process of liquidation Simple liquidation process is followed
agreement between parties

This involves credit/ default risk between the

Risk exposure No default risk
involved parties.

Price transparency Price transparency No price transparency

Minimal regulation without the involvement

Listed on stock exchanges with standardised
Regulation of stock exchanges or any formal
terms and conditions
intermediary.
Participants of Derivative Market
Different Types of Derivatives in India
• There are four types of derivatives that can be traded in the Indian stock market. Each type of derivative
differs from the other and has different contract conditions, risk factor, etc. The different types of derivatives
are as follows:
• Forward Contracts • Future Contracts • Options Contracts • Swap Contracts
Forward Contracts
When two parties enter into an agreement to buy or sell an underlying asset at a specified date and at an
agreed price in the future, it is termed as a forward contract. Forward contracts are an agreement between the
parties to sell something on a future date.
The forward contracts are customized and have high counterparty risk. Since the contract is customized, the
size of the contract depends on the term of the contract. 
Futures Contracts
In the futures contract, the buyer and seller are not required to meet each other to enter into an agreement. In
fact, the agreement between them is done via exchange. Since there is a standardized contract in the futures
contract, the counterparty risk is very low.
In addition, the clearing house acts as a counterparty to the parties of the contract which further reduces the
credit risk. in simple words, future contracts have pre-decided format, pre-decided expiry period and pre-
decided size.
In future contracts, initial margin is required as collateral and settlement is done on a daily basis.
Option Contracts
Options contracts are the third type of derivatives contract. Options contracts are very different from futures
and forwards contracts as there is no compulsion to discharge the contract on a certain date. Options contracts
are those contracts that give the right but not the obligation to buy or sell an underlying asset. There are two
types of options:
• In the call option, the buyer has the right to buy an underlying asset at a price determined while entering
the contract.
• While in the put option, the buyer has the right but not the obligation to sell an underlying asset at a price
determined while entering the contract.
In both the contracts the buyer has the option to settle the contracts on or before the expiry period. Options
are traded at over the counter market and at the stock exchange.

Swap Contracts
swap contracts are the most complicated. Swap contracts are private agreements between two parties. The
parties to the contract agree to exchange their cash flow in the future as per a predetermined formula. The
underlying security under swap contracts is interest rate or currency. Since both interest rate and currency are
volatile in nature, it makes swap contracts risky. Swap contracts protect the parties from various risks. These
contracts are not traded on the exchanges and investment bankers are the middlemen to these contracts.

To conclude, derivatives contracts like forwards, futures and options are one of the best hedging instruments.
The traders can predict future price movements and make good profits out of them.
Distinction between Futures and Options:

• In the case of options Contract, only the seller

• In a futures contract, both parties are obligated to
(writer) is obligated to perform.
perform.
• In an options contract, the buyer pays the seller
• In the case of futures, neither party pays a
(writer) a premium.
premium.
• In the case of options, the buyer is able to limit
• In the case of futures, the holder of the contract is
the downside risk to the option premium but
exposed to the entire spectrum of risk of loss and
retains the upside potential.
has the potential for all the returns.

• The parties to a future contract must perform at • . The buyers of an options contract can exercise

the settlement date. They are, however, not their right any time prior to that expiration date.

obligated to perform before the settlement date

futures and options are standardized Earn money on shares that are lying idle: Here don’t want to sell the

contracts, which can be freely traded on shares that you bought for long term, but want to take advantage of
price fluctuations in the short term. You can use derivative
exchanges. These could be employed to
instruments to do so. Derivatives market allows you to conduct
meet a variety of needs.
transactions without actually selling your shares – also called as
physical settlement.
Protect your securities against : fluctuations in prices The
derivative market offers products that allow you to hedge yourself
against a fall in the price of shares that you possess. It also offers
products that protect you from a rise in the price of shares that you
plan to purchase. This is called hedging.

Benefit from arbitrage: Transfer of risk : derivatives is the transfer of market risk from
When you buy low in one market and sell high in the risk-averse investors to those with an appetite for risk. Risk-
other market, it called arbitrage trading. Simply put, averse investors use derivatives to enhance safety, while risk-
you are taking advantage of differences in prices in loving investors like speculators conduct risky, contrarian
the two markets. trades to improve profits. This way, the risk is transferred.
 Futures Contracts
A futures contract is an agreement between two parties –
a buyer and a seller – wherein the former agrees to
purchase from the latter, a fixed number of shares or an
index at a specific time in the future for a pre-determined
price. These details are agreed upon when the transaction
takes place. As futures contracts are standardized in
terms of expiry dates and contract sizes, they can be
freely traded on exchanges.

Futures contracts are available on different kinds of

assets – stocks, indices, commodities, currency pairs and
so on. Here we will look at the two most common futures
contracts – stock futures and index futures.
How to Buy and Sell Futures Contracts
• Buying and selling futures contract is essentially the same as buying or selling a number
of units of a stock from the cash market, but without taking immediate delivery. In the
case of index futures too, the index’s level moves up or down, replicating the movement
of a stock price. So, you can actually trade in index and stock contracts in just the same
way as you would trade in shares. Markets face volatility.
HOW TO BUY FUTURES CONTRACTS
• One of the prerequisites of stock market trading – be it in the derivative segment – is a
trading account.

• Money is the obvious other requirement. However, this requirement is slightly different
for the derivatives market.

• When you buy in the cash segment, you have to pay the entire value of the shares
purchased – this is unless you are a day trader utilizing margin trading. You have to pay
this amount upfront to the exchange or the clearing house.
 • This upfront payment is called ‘Margin Money’. It helps reduce the risk that the exchange undertakes and helps in
maintaining the integrity of the market.
• Once you have these requisites, you can buy a futures contract. Simply place an order with your broker, specifying the
details of the contract like the Scrip , expiry month, contract size, and so on. Once you do this, hand over the margin
money to the broker, who will then get in touch with the exchange.
• The exchange will find you a seller (if you are a buyer) or a buyer (if you are seller)

• HOW TO SETTLE FUTURES CONTRACTS

• When you trade in futures contracts, you
do not give or take immediate delivery of
the assets concerned. This is called settling
of the contract. This usually happens on
the date of the contract’s expiry. However,
many traders also choose to settle before
the expiry of the contract. contracts can be
settled in two ways
On Expiry : In this case, the futures contract (purchase or sale) is settled at the closing price of the underlying asset as on the
expiry date of the contract.
Example: You have purchased a single futures contract of ABC Ltd., consisting of 200 shares and expiring in the month of July. At
that time, the ABC share’s price was Rs 1,000. If on the last Thursday of July, ABC Ltd. closes at a price of Rs 1,050 in the cash
market, your futures position will be settled at that price. You will receive a profit of Rs 50 per share (the settlement price of Rs
1,050 less your cost price of Rs 1,000), which adds up to a neat little sum of Rs 10,000 (Rs 50 x 200 shares). This amount is
adjusted with the margins you have maintained in your account. If you receive profits, they will be added to the margins that

you have deposited. If you made a loss, the amount will be deducted from the margins .

Before Expiry : It is not necessary to hold on to a futures contract till its expiry date. In practice, most traders exit their
contracts before their expiry dates. Any gains or losses you’ve made are settled by adjusting them against the margins you
have deposited till the date you decide to exit your contract. You can do so by either selling your contract, or purchasing an
opposing contract that nullifies the agreement. Here again, your profits will be returned to you or losses will be collected from
you, after adjusting them for the margins that you have deposited once you square off your position.

• Index futures contracts are settled in cash. This can again be done on expiry of the contract or before the expiry date.
What is Options Trading?
⮚ Options trading allows you to buy or sell stocks, ETFs etc. at a specific price within a specific date. This type of
trading also gives buyers the flexibility to not buy the security at the specified price or date.
⮚ options can help you make relatively larger profits if the price of the security goes up. That’s because you don’t
have to pay the full price for the security in an options contract. In the same way, options trading can restrict
your losses if the price of the security goes down, which is known as hedging.
⮚ The right to buy a security is known as ‘Call’, while the right to sell is called ‘Put’. They can be used as:
⮚ Leverage: Options trading help you profit from changes in share prices without putting down the full price of
the share. You get control over the shares without buying them outright.
⮚ Hedging : They can also be used to protect yourself from fluctuations in the price of a share and letting you
buy or sell the shares at a pre-determined price for a specified period of time. One of the integral parts of
hedging yourself against market fluctuations is to do financial planning. Here’s what Financial planning is and
why it important.
⮚ options trading is more complex than trading in regular shares. It calls for a good understanding of trading and
investment practices as well as constant monitoring of market fluctuations to protect against losses.

⮚ Just as futures contracts minimize risks for buyers by setting a pre-determined future price for an underlying
asset, options contracts do the same however, without the obligation to buy that exists in a futures contract.

⮚ The seller of an options contract is called the ‘options writer’. Unlike the buyer in an options contract, the
seller has no rights and must sell the assets at the agreed price if the buyer chooses to execute the options
contract on or before the agreed date, in exchange for an upfront payment from the buyer.

⮚ There is no physical exchange of documents at the time of entering into an options contract. The transactions
are merely recorded in the stock exchange through which they are routed.
 •Premium: The upfront payment made by the buyer to the seller to enjoy the
privileges of an option contract.
•Strike Price / Exercise Price: The pre-decided price at which the asset can
be bought or sold.
•Strike Price Intervals: These are the different strike prices at which an
options contract can be traded. These are determined by the exchange on
which the assets are traded.
There are typically at least 11 strike prices declared for every type of option
in a given month - 5 prices above the spot price, 5prices below the spot
price and one price equivalent to the spot price.

No. of Strikes Provided In the

Underlying Strike Price No. of additional strikes which
money-
Closing Price Interval may be enabled intraday in either direction
At the money- Out of the money
Less than or equal to
2.5 5-1-5 5
Rs.50
> Rs.50 to = Rs.100 5 5-1-5 5
> Rs.100 to = Rs.250 10 5-1-5 5
> Rs.250 to = Rs.500 20 5-1-5 5
> Rs.500 to = Rs.1000 20 10-1-10 10
> Rs.1000 50 10-1-10 10
EXPIRATION DATE:
A future date on or before which the options contract can be executed. Options contracts have three different
durations you can pick from: Near month (1 month) Middle Month (2 months) Far Month (3 months)
long terms options are available for Nifty index. Futures & Options contracts typically expire on the last Thursday
of the respective months, post which they are considered void.
AMERICAN AND EUROPEAN OPTIONS:
The terms ‘American’ and ‘European’ refer to the type of underlying asset in an options contract and when it can
be executed. American options’ are Options that can be executed at any time on or before their expiration date.
‘European options’ are Options that can only be executed on the expiration date.
Please note that in Indian market only European type of options are available for trading.

•LOT SIZE:
Lot size refers to a fixed number of units of the underlying asset that form part of a single F&O contract. The
standard lot size is different for each stock and is decided by the exchange on which the stock is traded.
E.g. options contracts for Reliance Industries have a lot size of 250 shares per contract.
•OPEN INTEREST:
Open Interest refers to the total number of outstanding positions on a particular options contract across all
participants in the market at any given point of time. Open Interest becomes nil past the expiration date for a
particular contract.
Let us understand with an example: If trader A buys 100 Nifty options from trader B where, both traders A and B
are entering the market for the first time, the open interest would be 100 futures or two contract. The next day,
Trader A sells her contract to Trader C. This does not change the open interest, as a reduction in A’s open position
is offset by an increase in C’s open position for this particular asset. Now, if trader A buys 100 more Nifty Futures
from another trader D, the open interest in the Nifty Futures contract would become 200 futures or 4contracts.
TYPES OF OPTIONS : As described earlier, options are of two types, the ‘Call Option’ and the ‘Put Option’.

CALL OPTION : The ‘Call Option’ gives the holder of the option
the right to buy a particular asset at the strike price on or before
the expiration date in return for a premium paid upfront to the
seller. Call options usually become more valuable as the value
of the underlying asset increases. Call options are abbreviated
as ‘C’ in online quotes

PUT OPTION: The Put Option gives the holder the right to sell a
particular asset at the strike price anytime on or before the
expiration date in return for a premium paid up front. Since you
can sell a stock at any given point of time, if the spot price of a
stock falls during the contract period, the holder is protected
from this fall in price by the strike price that is pre-set. This
explains why put options become more valuable when the price
of the underlying stock falls.
 This means, under this contract, Rajesh has the rights
HOW TO TRADE IN OPTIONS
to buy one lot of 100 Infosys shares at Rs 3000 per
share any time between now and the month of May.
He paid a premium of Rs 250 per share. He thus pays
a total amount of Rs 25,000 to enjoy this right to sell.

suppose the share price of Infosys rises over Rs 3,000

to Rs 3200, Rajesh can consider exercising the option
and buying at Rs 3,000 per share. He would be saving
Rs 200 per share; this can be considered a tentative
profit. However, he still makes a notional net loss of Rs
50 per share once you take the premium amount into
consideration. For this reason, Rajesh may choose to
actually exercise the option once the share price
crosses Rs 3,250 levels. Otherwise, he can choose to
let the option expire without being exercised.
 If the spot price for Company X falls below the Put
option Rajesh bought, say to Rs 1020; Rajesh can
safeguard his money by choosing to sell the put
option. He will make Rs 50 per share (Rs 1070
minus Rs 1020) on the trade, making a net profit of
Rs 20,000 (Rs 50 x 1000 shares – Rs 30,000 paid as
premium).

Rajesh believes that the shares of Company X are Alternately, if the spot price for Company X rises

currently overpriced and bets on them falling in the next higher than the Put option, say Rs 1080; he would be

few months. Since he wants to secure his position, he at a loss if he decided to exercise the put option at Rs

takes a put option on the shares of Company X. 1070. So, he will choose, in this case, to not exercise
the put option. In the process, he only loses Rs 30,000
Rajesh buys 1000 shares of Company X Put at a strike – the premium amount; this is much lower than if he
price of 1070 and pays Rs 30 per share as premium. His had exercised his option
total premium paid is Rs 30,000.
• Hedging refers to an investment whose aim is to reduce the level of
future risks in the event of an adverse price movement of an asset.
Hedging provides a sort of insurance cover to protect against losses
from an investment.

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• The term “financial derivative” relates with a variety of financial instruments which
include stocks, bonds, treasury bills, interest rate, foreign currencies and other
hybrid securities. Financial derivatives include futures, forwards, options, swaps, etc.

• The term financial market derivative can be defined as a treasury or capital market
instrument which is derived from, or bears a close relation to a cash instrument or
another derivative instrument.

• Futures contracts are the most important form of derivatives, which are in existence
long before the term ‘derivative’ was coined.

• Financial derivatives can also be derived from a combination of cash market

instruments or other financial derivative instruments.