There are four different types of derivatives that can easily be traded in the Indian Stock Market. Each derivative is different from the other and consist of varying contract conditions, risk factor and more.
Forward Contracts Future Contracts Options Contracts Swap Contracts Let us have a look and study in-depth detail about these derivatives.
Forward Contracts Forward contracts mean two parties come together and enter into an agreement to buy and sell an underlying asset set at a fixed date and agreed on a price in the future.
In simpler words, it is an agreement formed between both parties to sell their asset on an agreed future date.
The forward contracts are customized and have a high tendency of counterparty risk. Since it is a customized contract, the size of the agreement entirely depends on the term of the contract.
Forward contracts do not require any collateral as they are self-regulated. The settlement of the forward contract gets done on the maturity date, and hence they are reserved by the expiry period.
Future Contracts Future contracts are similar to forward contracts. Future contracts mean an agreement made by the two parties to buy or sell an underlying instrument at a fixed price on a future date.
Future contracts do not allow the buyer and seller to meet and enter into an agreement. In fact, the deal gets fixed through exchange mode.
In futures contracts, the counterparty risk is low because it is a standardized contract. In addition, the clearinghouse plays the role of a counterparty to the parties of the contract, which reduces the credit risk in the future.
The size of future contracts is fixed, and it is regulated by the stock exchange just because it is known as a standardized contract.
Since these contracts are standard, the futures contracts listed on the stock exchange cannot be changed or modified in any possible way.
In simpler words, future contracts have pre-decided size, pre-decided expiry period, pre-decided size. In futures contracts, an initial margin is required because settlement and collateral are done daily.
Options Contracts Options contracts are the third type of derivative contracts in India. Options contracts are way different than future and format contracts because these contracts do not require any compulsion to discharge the contract on a specific date.
Options contracts provide the right but not the commitment to buy or sell an underlying instrument.
Option contracts consist of two options:
Incall option, the buyer has all the right to purchase an underlying asset at a fixed price while entering the contracts. While input option, the buyer has all the right but not obligation to sell an underlying asset at a fixed price while entering the contract.
However, in both call and put option contracts, the buyer chooses to settle all the contracts on or before the expiry period.
Thus, anyone who regularly trades in the option contract can take any of the four different positions, i.e., short or long, either in the call or the put option. These options are traded at the stock exchange and over the counter market.
Swap Contracts Out of all three derivatives contracts, swap contracts are one of the most complex contracts.
Swap contracts mean the agreement is done privately between both parties. The parties who enter into swap contracts agree to exchange their cash flow in the future as per the pre-determined formula.
Under swap contracts, the underlying security is the interest rate or currency, as these contracts protect both parties from several major risks.
These contracts are not traded to the Stock Exchange as investment banker plays the role of a middleman between these contracts.
FAQs
Derivatives are financial contracts that derive their value from an underlying asset such as stocks, commodities, currencies etc., and are set between two or more parties, where the value of the derivative is derived from price or value fluctuations of the underlying assets.
What are derivatives in Indian financial system? ›
Derivatives are financial contracts that derive their value from an underlying asset such as stocks, commodities, currencies etc., and are set between two or more parties, where the value of the derivative is derived from price or value fluctuations of the underlying assets.
What are the 4 main derivatives? ›
The four major types of derivative contracts are options, forwards, futures and swaps.
Which is the first derivative in India? ›
The National Stock Exchange of India Limited (NSE) commenced trading in derivatives with the launch of index futures on June 12, 2000. The futures contracts are based on the popular benchmark Nifty 50 Index. The Exchange introduced trading in Index Options (also based on Nifty 50) on June 4, 2001.
What are derivatives in Indian financial market? ›
The Indian financial market is made up of a variety of markets, including the stock market, the bond market, the derivatives market, the foreign exchange market, and the money market.
How many types of derivatives are there in India? ›
There are four different types of derivatives that can easily be traded in the Indian Stock Market. Each derivative is different from the other and consist of varying contract conditions, risk factor and more. The four different types of derivatives are as follows: Forward Contracts.
Which type of derivatives are popular in India and explain them briefly? ›
Some of the best hedging instruments are derivatives contracts like forward contracts, futures, options, and swap contracts. Traders have the opportunity to predict price movements using these derivatives contracts and thereby improve their margin for gains through them.
What are the top 5 derivatives? ›
Five of the more popular derivatives are options, single stock futures, warrants, a contract for difference, and index return swaps.
What are the different types of derivatives in finance? ›
In finance, there are four basic types of derivatives: forward contracts, futures, swaps, and options.
What are the different types of derivatives and explain them? ›
Derivatives are financial instruments whose value is derived from other underlying assets. There are mainly four types of derivative contracts such as futures, forwards, options & swaps. However, Swaps are complex instruments that are not traded in the Indian stock market.
Thus, the enactment of Securities Law (Amendment) Act, 1999 and repeal of the 1969 notification provided a legal framework for securities based derivatives on stock exchanges in India, which is co-terminus with framework of trading of other securities allowed under the Act.
Who introduced derivatives in India? ›
The exchange traded derivatives started in India in June 2000 with SEBI permitting BSE and NSE to introduce the equity derivatives segment. To begin with, SEBI approved trading in index futures contracts based on Nifty and Sensex, which commenced trading in June 2000.
Who controls derivatives market in India? ›
SEBI establishes the regulatory framework governing derivatives in India. It formulates rules, regulations, and guidelines concerning the trading, clearing, and settlement of derivative contracts.
How do derivatives work in India? ›
Derivative trading lets you hedge your position in the cash market. For example, if you buy a positional stock in the cash market, you can buy a Put option in the derivative market. If the stock tumbles in the cash market, the value of your Put option will increase. Hence, your losses will be minimal or nil.
What is the role of derivatives in India? ›
In the context of the Indian securities market, derivatives play a significant role in shaping investment strategies, hedging risks, and fostering liquidity. This article delves into the intricacies of the derivatives market, exploring its types, functions, importance, advantages, and potential drawbacks.
What is the role of derivatives in Indian economy? ›
Derivatives markets promote capital efficiency by increasing the exposure to underlying assets without the need for large capital outlays. Derivatives allow a trader to control a significant position in a stock index by purchasing futures contracts that require only a fraction of the underlying asset's value as margin.
What is an example of a derivatives market in India? ›
For example Stock index futures, stock index options and Stock futures and options in India are exchange traded derivatives. OTC derivatives are private bilateral contracts between two parties and are non standardised. These derivatives are specific to the needs of the parties involved.
What are derivatives and its impact on Indian financial system? ›
Derivatives are the hedging instruments which are designed to manage, control price risks and to balance exchange rate for globally traded goods. These instruments reduce the impact of fluctuation by locking in asset prices and also improve the credit allocation in the economy.
