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
There are four main types of derivatives: forward contracts, futures contracts, options contracts, and swap contracts.
What are the 4 main derivatives? ›
In finance, there are four basic types of derivatives: forward contracts, futures, swaps, and options.
What are the derivatives trade in India? ›
India has two types of derivative markets: the exchanges-traded market and the over-the-counter (OTC) market. The exchanges-traded market is where standardised contracts are traded on an exchange. The OTC market is decentralised, where contracts are negotiated directly between two parties.
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.
What are derivative works in India? ›
A derivative work is a creation that is based on or derived from an original copyrighted work, thereby giving rise to a new work with its own set of rights and obligations. In India, the legal framework governing derivative works is outlined in the Copyright Act, 1957, and its subsequent amendments.
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. Options let investors hedge risk or speculate by taking on more risk. A stock warrant means the holder has the right to buy the stock at a certain price at an agreed-upon date.
What are the two most common derivatives? ›
Common underlying assets include investment securities, commodities, currencies, interest rates and other market indices. There are two broad categories of derivatives: option-based contracts and forward-based contracts.
What are the most commonly used derivatives? ›
Option products (e.g., stock options), on the other hand, offer the holder the right, but not the obligation, to buy or sell the underlying asset or security at a specific price on or before the option's expiration date. The most common derivative types are futures, forwards, swaps, and options.
Is ETF a derivative? ›
Exchange-traded funds (ETFs) are not derivatives. They are pools of money used to buy, hold, and sell a selection of stocks, bonds, or other assets. Their investments do not generally include derivatives. Some specialized ETFs use derivatives like options or futures contracts for specific purposes, such as hedging.
How big is Indian derivatives market? ›
The notional volume of equity derivative trading in India reached $6 trillion in early February, a six-fold surge since the start of 2022, before easing recently. This “unchecked retail surge” could led to future challenges for the markets as well as for household finances, Sitharaman said last week.
Market Watch - Commodity Derivatives
| INSTRUMENT TYPE | SYMBOL | High |
|---|
| Options on Futures | CRUDEOIL | 14.20 |
| Options on Futures | CRUDEOIL | 17.90 |
| Options on Futures | NATURALGAS | 0.10 |
| Options on Futures | CRUDEOIL | 185.00 |
11 more rowsEquity derivatives are financial instruments whose value is derived from price movements of the underlying asset, where that asset is a stock or stock index. Traders use equity derivatives to speculate and manage risk for their stock portfolios.
Who controls derivatives market in India? ›
Furthermore, ETDs such as futures and options have grown, making the National Stock Exchange of India the world's largest derivatives exchange. ETDs are controlled and supervised by the exchanges and further regulated by SEBI.
What are currency derivatives in India? ›
Currency Derivatives are exchange-traded contracts deriving their value from their underlying asset, i.e., the currency. The investor buys or sells specific units of fixed currency on a pre-specified date and rate.
What are forward derivatives in India? ›
The parties can settle forward derivatives in one of the two ways. One is where the seller makes physical delivery of the assets and receives the agreed-upon payment by the buyer. The other is where cash settlement occurs, and there is no actual physical delivery of the asset in question.
Which is India largest derivative market? ›
National Stock Exchange of India (NSE) is the world's largest derivatives exchange for the fifth consecutive year in 2023.
Which derivatives are traded on the stock exchange in India? ›
The most common derivatives trading instruments in India are futures and options. While futures provide you with the right and obligation to buy or sell the underlying asset at a future date, options give you the right, not the obligation, to buy or sell the underlying asset at a future date.
