What are Derivatives in Indian Stock Market?

Published by Sharekhan Education | November 7, 2023

By Fahim Ansari | Sharekhan Education

In the context of the stock market, derivatives are financial instruments whose value is derived from an underlying asset, which can be a stock, index, currency, commodity, or any other financial instrument. Derivatives are essentially contracts between two parties that derive their value from the price of the underlying asset. They are used for various purposes, including hedging against price fluctuations, speculating on future price movements, and portfolio management.

Types of Derivatives:

The Indian stock market trades several types of derivatives, like:

Futures:

These standardized contracts obligate the buyer to purchase and the seller to sell the underlying asset at a specified future date and at a predetermined price. Market participants often use these contracts for hedging against price fluctuations or engaging in speculative trading. In the Indian context, stock futures trading are quite popular, where investors can take positions on the future price movements of individual stocks.

Options:

Options give the holder the right but not the obligation to buy (call option) or sell (put option) an underlying asset at a predetermined price within a specified time frame. They are widely used for hedging, income generation, and speculation. In India, stock options trading and index options are actively traded.

Stock Futures:

These are futures contracts based on individual stocks. Stock futures allow investors to speculate on the future price movements of a specific stock.

Stock Options:

These are options contracts based on individual stocks. Investors can use stock options to hedge against stock price movements or to engage in various trading strategies.

Index Futures:

These are futures contracts based on market indices like the Nifty 50, Bank Nifty, or the Sensex. Investors use index futures to speculate on the overall market direction.

Index Options:

These are option contracts based on market indices. Investors use index options for strategies related to broad market movements.

Purpose of Derivatives in the Indian stock market:

Risk Management:

Investors and traders use derivatives to hedge against price fluctuations. For example, a stockholder may use index futures to hedge their portfolio against a market downturn.

Speculation:

Many traders use derivatives to speculate on the future price movements of underlying assets. They can profit from both rising and falling markets.

Arbitrage:

Arbitrageurs take advantage of price differentials between the cash (spot) market and the derivatives market to make risk-free profits.

Conclusion:

The Securities and Exchange Board of India (SEBI) regulates derivatives trading in the Indian stock market, and stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) conduct it.

Derivatives play a significant role in the Indian stock market, offering various opportunities for investors and traders. However, it’s important to note that derivatives trading can be complex and carries a higher level of risk compared to investing in the underlying assets. Therefore, it’s crucial for investors and traders to have a good understanding of the market, the instruments traded in the market,and risk management strategies before participating in derivative trading.

Disclaimer:

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