I

ntr
oduct
iont
oDer
ivat
ives
Basi
csofDer
ivat
ives
Deri
vati
vei
salsoaFi
nanci
alI
nst
rument
,whi
chder
ivet
hei
rval
uef
rom some
underl
yi
ngasset
s.

Der
ivat
ivecannotexi
sti
nisol
ati
on.

Def i
nit
ion:I
tisacont
ractoraproductwhosevalueisderi
vedfrom val
ueofsome
otherassetknown asunderly
ing asset
s.(underl
yi
ng asset
,index,orref
erence
rate/curr
ency)
.

Der
ivat
ivesar
ebasedonwi
der
angeofunder
lyi
ngasset
s.

Thesei
ncl
ude:

Fi
nanci
alasset
ssuchasEqui
ty(
Shar
es)

Debt(
Bonds,
T-bi
l
lsandnot
es)

Cur
renci
es(
For
eignExchange)

I
ndi
cesoft
hesev
ari
ousasset
s(Ni
ft
y50I
ndex)

Commodi
ti
eswhi
chi
ncl
udes-

Met
alssuchasGol
d,Si
l
ver
,Al
umi
nium,
Copper
,Zi
nc,
Nickel
,Ti
n,Lead

Ener
gyr
esour
cessuchasOi
landGas,
Coal
,El
ect
ri
cit
y

Agr
icommodi
ti
essuchaswheat
,Sugar
,Cof
fee,
Cot
ton,
Pul
sesand

Forexample,
wheatf armersmaywi sht
osel
lthei
rharvestatafutur
edat
eto
el
iminat
etheriskofachangei npr
icesbyt
hatdate.Suchat r
ansact
ioni
san
exampleofaderivat
ive.Thepri
ceofthi
sderi
vati
veisdri
venbythespotpri
ceof
wheatwhichisthe"underl
ying"
.

Fact
orsi
nfl
uenci
ngt
hegr
owt
hofder
ivat
ivemar
ket
Overthelastthreedecades,deri
vat
ivesmar kethasseenaphenomenalgr
owt
h.
Manyderivat
ivecont
ractswerelaunchedatexchangesacrosst
heworl
d.Someof
t
hefactor
sdrivi
ngthegrowthoffi
nancialder
ivati
vesar
e:

I
ncr
easedf
luct
uat
ionsi
nunder
lyi
ngassetpr
icesi
nfi
nanci
almar
ket
s.

I
ntegr
ati
onoff
inanci
almar
ket
sgl
obal
l
y.

Useofl
atestt
echnol
ogyi
ncommuni
cat
ionshashel
pedi
nreduct
ionoft
ransact
ion
cost
s.

Enhancedunder
standi
ngofmar
ketpar
ti
cipant
sonsophi
sti
cat
edr
iskmanagement

1
ByPr
ofKomalTr
ivedi
 I
ntr
oduct
iont
oDer
ivat
ives
t
ool
stomanager
isk.

Fr
equenti
nnov
ati
onsi
nder
ivat
ivesmar
ketandnewerappl
i
cat
ionsofpr
oduct
s.

TypesofDer
ivat
ivesMar
ket(
Tradi
ngMechani
sm)
Regul
atedExchangeTr
aded(
NSCet
c.)

Ov
er-
the-
count
er(
OTC),
dir
ect
lybet
weent
hedi
ff
erentpar
ti
es

I
nIndi
aonlyexchangestradedequi
tyder
ivat
ives(
stockbasedder
ivat
ive)ar
e
per
mit
tedunderthelaw.

Int hemoder nworl

d, t
hereisahugev ariet
yofder i
vati
veproduct savail
able.Theyar e
eithertradedonorganisedexchanges( cal
ledexchanget r
adedder ivat
ives)oragr eed
directlybetween the contracting counterpar
ties overthe telephone ort hr
ough
elect r
onic medi
a( call
ed Ov er-t
he-counter (OTC) derivat
ives).Ov er-t
he-counter
mar ketisnotaphy sicalmar ketpl
acebutacol l
ecti
onofbr oker-deal
ersscat tered
acr ossthecount
ry.

Basi
cPur
poseofDer
ivat
iveTr
adi
ng
Transf
erthepr
icer
iskt
hatar
isesbecauseoff
luct
uat
ionsofassetpr
icesf
rom
onepartytoot
her

Mi
ti
gat
ether
iskbecauseoff
utur
euncer
tai
ntyofpr
ices

Thepr
iceofder
ivat
ivei
sdr
ivenbyt
hespotpr
iceoft
he
under
lyi
ng

Pr
oduct
sinDer
ivat
ivesMar
ket(
Kindsofder
ivat
ives)
Forwards: Iti s a cont
ractualagreementbet ween two par ti
es to buy/sellan
underl
yingassetatacer t
ainf ut
uredateforapar t
icul
arpr
icet hatispre-decidedon
thedateofcont ract
.Boththecont r
acti
ngparti
esar ecommi tt
edandar eobligedto
honourt hetransact
ionir
respecti
veofpr i
ceoft heunderl
yingassetatt het imeof
deli
ver
y .Since forwards are negoti
ated bet
ween t wo parties,the t er
ms and
condit
ionsofcont r
actsar
ecust omized.TheseareOTCcont racts.

Futur
es:Afuturescontr
actissimil
artoaf or
ward,exceptt
hatthedeali
smade
thr
oughanorganizedandregul
atedexchanger
atherthanbei
ngnegot
iat
eddir
ect
ly

2
ByPr
ofKomalTr
ivedi
 I
ntr
oduct
iont
oDer
ivat
ives
betweentwopar
ti
es.I
ndeed,wemaysayf
utur
esar
eexchanget
radedf
orwar
d
contr
act
s

Options:AnOptionisacontractthatgiv
estheri
ght,butnotanobligat
ion,tobuyor
selltheunderl
yi
ngonorbef oreast ateddateandatast at
edprice.Whi l
ebuy erof
optionpay sthepremium andbuy stheri
ght,wri
ter/
sel
lerofoptionr ecei
v esthe
premi um wi
thobli
gati
ontosell/buytheunderl
yingasset
,ifthebuyerexerciseshis
ri
ght .

Mar
ketPar
ti
cipant
sinDer
ivat
iveMar
ket
Ther
ear
ebr
oadl
ythr
eet
ypesofpar
ti
cipant
sint
heder
ivat
ivesmar
ket

Hedger
s,Tr
ader
s(al
socal
l
edspecul
ator
s)andAr
bit
rageur
s

Ani
ndi
vi
dual
maypl
aydi
ff
erentr
olesi
ndi
ff
erentmar
ketci
rcumst
ances.

Hedgerst heyf aceri

skassoci at
edwi tht hepricesofunderl
y i
ngasset
sanduse
deri
vati
vest oreducetheirri
sk.Cor
porations,i
nvesti
nginst
it
uti
onsandbanksalluse
deri
vati
vepr oductstohedgeorr educet hei
rexposurestomarketvar
iabl
essuchas
i
nterestrates,sharevalues,bondprices,curr
encyexchanger at
esandcommodi ty
pri
ces.

Speculator
st heytrytopredictt
hef ut
uremov ementsinpricesofunderl
yi
ngassets
and based on t he vi
ew,t ake posit
ions in der
ivat
ive contract
s.Deri
vati
ves ar
e
pref
erredov erunderl
yingassetforspeculationpurpose,ast heyoff
erl
everage,ar
e
l
essexpensi ve(costoftr
ansacti
onisgener al
lylowerthanthatoftheunderl
yi
ng)and
arefastert
oexecut einsize(hi
ghvolumesmar ket
).

Ar
bi t
rageurs,Arbi
trageisadealthatpr
oducespr ofi
tbyexpl oi
ti
ngapr i
cediff
erence
i
napr oductintwodi ff
erentmarket
s.Arbi
trageori
ginateswhenat raderpurchases
anassetcheapl yi nonelocati
onandsi mul
taneouslyarrangestosel li
tatahi gher
pr
icei nanot herlocat
ion.Suchopportuni
ti
esar eunlikel
yt oper si
stforv er
ylong,
si
ncear bit
rageurswoul drushi
nt ot
hesetransacti
ons,thusclosingthepricegapat
di
fferentl
ocat i
ons.

Si
gni
fi
canceofDer
ivat
ives
Der
ivat
ivesMar
ketser
vesf
oll
owi
ngspeci
fi
cfunct
ions:

3
ByPr
ofKomalTr
ivedi
 I
ntr
oduct
iont
oDer
ivat
ives
Deri
vati
vesmar kethel
psi
nimpr
ovi
ngpr
icedi
scov
erybasedonact
ualv
aluat
ions
andexpectat
ions.

Der
ivat
ivesmar
kethel
psintransf
erofvari
ousr
isksfrom t
hosewhoar
eexposed
t
ori
skbuthavel
owriskappet
it
etopart
ici
pantswi
thhighri
skappet
it
e.

Forexampl
ehedger
swantt
ogi
veawayt
her
iskwher
east
rader
sar
ewi
l
li
ngt
otake
r
isk.

Deri
vat
ivesmar kethelpsshi
ftofspecul
ati
vetradesfr
om unorgani
zedmar kett
o
organi
zedmar ket
.Riskmanagementmechani sm andsurvei
l
lanceofactiv
iti
esof
vari
ouspar
tici
pantsinorgani
zedspaceprovi
destabil
it
ytothef
inanci
alsy
stem.

Var
iousr
iskf
acedbyt
hepar
ti
cipant
sinder
ivat
ives
MarketPar
tici
pant
smustunder
standt
hatder
ivat
ives,bei
ngl
ever
agedi
nst
rument
s,
hav
er i
sksl
ike

count
erpar
tyr
isk(
def
aul
tbycount
erpar
ty)
,

pr
icer
isk(
lossonposi
ti
onbecauseofpr
icemov
e),

l
i
qui
dit
yri
sk(
inabi
l
ityt
oex
itf
rom aposi
ti
on)
,

l
egal
orr
egul
ator
yri
sk(
enf
orceabi
l
ityofcont
ract
s),

oper
ati
onal
risk(
fraud,
inadequat
edocument
ati
on,
impr
operexecut
ion,
etc.
)

t
radi
ngexper
ienceandl
owr
iskt
oler
ance.

A marketpar t
ici
pantshouldther efor
ecarefull
yconsiderwhethersucht radingi s
sui
tabl
ef orhim/herbasedont heseparameters.Marketparti
cipants,whot radei n
deri
vat
ives,areadvi
sedt ocar
efullyreadtheModelRiskDisclosureDocument ,given
bythebrokertohisclient
satthet imeofsigningagr
eement .ModelRi skDiscl osure
Documenti si ssued by the member s ofExchanges and cont ains impor tant
i
nformationont r
adinginEquit
iesandF&OSegment sofexchanges.Al lpr
ospect ive
part
ici
pants shouldread thi
s documentbef oretr
ading on CapitalMar ket/Cash
SegmentorF&Osegmentoft heExchanges.

Economi
cfunct
ionofder
ivat
ives
Despi
tet
hef
earandcr
it
ici
sm wi
thwhi
cht
heder
ivat
ivemar
ket
sar
ecommonl
y
4
ByPr
ofKomalTr
ivedi
 I
ntr
oduct
iont
oDer
ivat
ives
l
ookedat
,thesemar
ket
sper
for
m anumberofeconomi
cfunct
ions.

1.Pr i
ces i
n an or
ganized deri
vati
ves marketr ef
lectthe per
cept
ion ofmar ket
part
ici
pant
saboutthefutureandleadthepr
icesofunder ly
ingtot
heperceivedf
uture
l
evel.Thepricesofderivati
vesconvergewiththepr icesoftheunderl
yingatt he
expi
rati
onoft hederi
vati
v econt
ract.Thusderivati
veshel pi
ndiscoveryoffuture
pri
ces.

2.Thederi
vat
ivesmarkethel
pstot
ransf
erri
sksfrom t
hosewhohav
ethem butmay
notl
i
kethem t
ot hosewhohaveanappet
it
eforri
sks.

3.Deri
vat
ives,duetot
hei
rinherentnatur
e,arelinkedtotheunderly
ingcashmar kets.
Withthei
nt r
oducti
onofderiv
ativ
es,theunderlyingmar ketwi
tnesseshighertrading
vol
umes because ofpar t
ici
pation by mor e players who would notot herwise
part
ici
pat
ef orl
ackofanarr
angementt otransferrisk.

4.Specul
ativ
et r
adesshifttoamorecont r
oll
edenv ir
onmentofderivat
ivesmarket.I
n
theabsenceofanor ganizedder
ivati
vesmar ket,specul
atorstr
adeint heunder
lyi
ng
cashmar kets.Margi
ning,monit
oringandsur v
eill
anceoft heactivi
ti
esofv ari
ous
part
ici
pantsbecomeext r
emelydi
fficul
tinthesetypesofmi xedmarkets.

5.Ani mportanti
nci
dentalbenefitt
hatflowsfrom deri
vati
vest r
adingi
st hatitacts
asacat aly
stf ornew entrepr
eneurialacti
vi
ty.Theder iv
ativ
eshav eahi st
oryof
att
ract
ing many bright
,cr eat
ive,well-
educated peopl
e wi t
h an entrepreneuri
al
att
it
ude.Theyof t
enener gi
zeotherst ocreatenew businesses,new pr
oduct sand
newempl oymentopport
uniti
es,thebenefi
tsofwhichareimmense.

I
nanutshell
,der
ivat
ivesmarket
shelpincreasesav
ingsandinvestmenti
nthelong
r
un.Tr
ansf
erofri
skenablesmarketpar
ti
cipantst
oexpandthei
rvolumeofacti
vi
ty.

SomeI
mpor
tantTer
ms
SpotMar
ket
Al
socal
l
edcashmar
ket

Secur
it
iesar
esol
dforcashanddel
i
ver
edi
mmedi
atel
y

NSE
scashmar
ketsegmenti
sknownast
heCapi
talMar
ket(
CM)
Segment
.

Shar
esofPubl
i
clyl
i
stedcompani
esar
etr
aded

Set
tl
ementper
iodi
nthi
smar
keti
sonaT+2basi
s

I
ndex

5
ByPr
ofKomalTr
ivedi
 I
ntr
oduct
iont
oDer
ivat
ives
Identi
fyt
hegener
alt
rendi
nthemar
ketasawhol
eorapar
ti
cul
ar
sector

Basketofi
dent
if
iedst
ocks

Valuei
scomput edbytaki
ngt
hewei
ght
edav
erageoft
hepr
icesof
theconst
it
uentstocks

Ni
ft
yIndexist
hemostpopul
arstocki
ndexandi
tisbasedont
he
t
op50stockst
radedi
ntheMarket
.

6
ByPr
ofKomalTr
ivedi