Market derivatives are financial instruments whose value is intricately linked to the performance of an underlying asset. This underlying asset can be a stock, bond, commodity, or even a currency. Derivatives meaning in share market stems from its name “deriving value”.
The derivatives market is a vast and dynamic arena where these instruments are traded.
Derivative trading involves buying or selling derivatives with the goal of capitalising on price fluctuations in the underlying asset. There are various types of derivatives, including futures and options trading, share market derivatives or equity derivatives and currency derivatives. The growing popularity of derivatives trading has spurred the development of numerous derivatives app platforms, offering investors convenient tools and platforms to trade these instruments.
Let us look at the types of derivatives in detail:
Derivatives And Its Types In Detail With Examples
Below is a table representing different types of derivatives, their purpose, features and risks. These are derivatives trading strategies widely used by traders and investors in India.
| Derivative Type | Underlying Asset | Indian Exchanges | Purpose | Risks | Specific Features |
| Futures Contracts | Indices (Nifty 50, Sensex), stocks, commodities (gold, silver, crude oil), currencies (USD, GBP, EUR) | National Stock Exchange (NSE), Bombay Stock Exchange (BSE), Multi Commodity Exchange (MCX) | To buy or sell a specific asset at a predetermined price on a future date. | Price volatility, margin requirements. | Weekly and monthly expiry cycles. |
| Options | Indices (Nifty 50, Sensex), stocks, commodities (gold, silver, crude oil), currencies (USD, GBP, EUR) | National Stock Exchange (NSE), Bombay Stock Exchange (BSE), Multi Commodity Exchange (MCX) | To buy or sell an asset at a predetermined price within a specified time period (call option gives the right to buy, put option gives the right to sell). | Time decay, limited upside potential for options buyers. | Weekly and monthly expiry cycles, various option strategies like covered calls, protective puts, straddles. |
| Forwards | Customised agreements between two parties | Over-the-Counter (OTC) market | To buy or sell an asset at a predetermined price on a future date. | Counterparty risk, illiquidity. | Popular for interest rate swaps and currency forwards. |
| Swaps | Interest rates, currencies, commodities | Over-the-Counter (OTC) market | To exchange one stream of payments for another. | Counterparty risk, credit risk. | Popular for interest rate swaps and currency swaps. |
| Credit Derivatives | Credit risk of a specific entity | Over-the-Counter (OTC) market | To transfer credit risk from one party to another. | Counterparty risk, complexity. | Popular for credit default swaps (CDS). |
| Variance Swaps | Volatility of an underlying asset | Over-the-Counter (OTC) market | To trade volatility risk. | Complexity, illiquidity. | Used for hedging against market volatility. |
What Are Derivatives In Finance With Example
Examples of derivatives market in India includes the following:
- Futures contracts: An agreement to buy or sell a specific asset at a predetermined price on a future date. For example, a wheat futures contract would obligate the buyer to purchase a certain amount of wheat at a specified price on a specified date.
- Options: Contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified time period. For example, a call option on Apple stock would give the buyer the right to purchase Apple stock at a specified price on or before a specified date. There are different types of options in derivatives that can be used for different securities.
- Swaps: Agreements to exchange one stream of cash flows for another. For example, an interest rate swap might involve exchanging fixed-rate interest payments for floating-rate interest payments.
- Forwards: Similar to futures contracts, but typically customised agreements between two parties.
While making a demat account opening decision, you can look at the brokerage charges and risk management measures involved in these strategy applications.
Uses Of Derivatives Trading
- Hedging: Derivatives can be used to hedge against risk. For example, a company that is worried about rising oil prices can buy oil futures contracts to lock in a price.
- Speculation: Derivatives can also be used for speculation. For example, an investor who believes that the price of gold will rise can buy gold futures contracts.
- Arbitrage: Derivatives can be used to exploit price differences between different markets.
What Are Currency Derivatives
Here are a few common types of currency derivatives in India:
Currency Futures: Contracts that obligate the buyer to purchase a specific amount of a foreign currency at a predetermined price on a future date.
Currency Options: Contracts that give the buyer the right, but not the obligation, to buy or sell a specific amount of a foreign currency at a predetermined price within a specified time period.
Currency Swaps: Agreements to exchange one currency for another at a predetermined exchange rate.
Currency derivatives also involve different types of forex derivative strategy like hedging, carry trade, interest rate parity, momentum trading and more.
What Are Derivative Instruments
Derivatives are financial instruments whose value is derived from the value of an underlying asset. To trade in these instruments, you need a derivatives app. In India, a wide range of derivative instruments are traded on various exchanges, including:
Equity Derivatives
- Index Futures: Contracts that allow investors to buy or sell a predetermined quantity of a stock index at a specified price on a future date. Popular indices include the Nifty 50 and Sensex.
- Stock Futures: Contracts that allow investors to buy or sell a predetermined number of shares of a specific company at a specified price on a future date.
- Index Options: Options that give investors the right, but not the obligation, to buy or sell a predetermined quantity of a stock index at a specified price on a future date.
- Stock Options: Options that give investors the right, but not the obligation, to buy or sell a predetermined number of shares of a specific company at a specified price on a future date.
Commodity Derivatives
- Commodity Futures: Contracts that allow investors to buy or sell a predetermined quantity of a commodity at a specified price on a future date. Popular commodities include gold, silver, crude oil, and agricultural products.
- Commodity Options: Options that give investors the right, but not the obligation, to buy or sell a predetermined quantity of a commodity at a specified price on a future date.
Currency Derivatives
- Currency Futures: Contracts that allow investors to buy or sell a predetermined amount of a foreign currency at a specified price on a future date. Popular currencies include the US dollar, British pound, and euro.
- Currency Options: Options that give investors the right, but not the obligation, to buy or sell a predetermined amount of a foreign currency at a specified price on a future date.
Interest Rate Derivatives
- Interest Rate Futures: Contracts that allow investors to buy or sell a predetermined amount of a government bond at a specified price on a future date.
- Interest Rate Swaps: Agreements to exchange one stream of interest payments for another.
What Commonly Used Swaps In Derivatives Markets Are Available In India
Swaps are derivative contracts that involve the exchange of one stream of cash flows for another. They are used for risk management, return enhancement, and speculation. Common types include interest rate swaps, currency swaps, commodity swaps, Credit Default Swaps (CDS), and equity swaps.
For more information on financial instruments derived from underlying assets and mutual fund investing in derivatives, you can explore the Demat app
Conclusion
Derivatives are financial instruments whose value is derived from an underlying asset. Common types include futures, options, swaps, and forwards. They are used for hedging, speculation, and arbitrage. India has a vibrant derivatives market with various instruments traded on exchanges like NSE and BSE. Derivatives can be complex, and investors should understand the risks involved before trading.