Derivatives- Everything at single page

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Definition of Derivatives

Derivative is a product 

whose value is derived 

from the value of one or more variables, called underlying. 

The underlying asset can be equity, index, foreign exchange (forex), bonds, commodity, precious metals or any other asset. 

Derivative products initially emerged as hedging devices against fluctuations in commodity prices and commodity derivatives remained the sole form of such products for almost three hundred years. 

The financial derivatives came into spotlight in post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for approx 66% of total transactions in derivative products. 

Types of Derivatives

Four most common examples of derivative instruments are Forwards, Futures, Options and Swaps.

Forwards

Futures

Options

Swaps


Long and Short Positions

Long and short positions are used to denote buying and selling respectively. 

Long position denotes to buy the underlying asset on a certain specified future date for a certain specified price. 

Short position denotes to sell that asset on same future date for the same price. 

The specified price in a forward contract is referred to as the delivery price.


Brief History of Derivative Trading in India

The origin of derivatives can be traced back to the need of farmers to protect themselves against fluctuations in the price of their crop. From the time it was sown to the time it was ready for harvest, farmers would face price uncertainty. Through the use of simple derivative products, it was possible for them to transfer partially or fully price risks by locking-in asset prices.

Derivative markets in India have been in existence in one form or the other for a long time. 

In the area of commodities, the Bombay Cotton Trade Association started future trading way back in 1875. This was the first organized futures market. Then followed the Bombay Cotton Exchange Ltd. in 1893, Gujarat Vyapari Mandall in 1900, and Calcutta Hessian Exchange Ltd. in 1919. After the country attained independence, derivative market came. 

In 1952, the Government of India banned cash settlement and options trading, derivatives trading shifted to informal forwards markets. 

In recent years the government policy has shifted in favour of an increased role at market-based pricing and less suspicious derivatives trading. 

The first step towards the introduction of financial derivatives trading in India was the promulgation the Securities Laws (Amendment) Ordinance 1995. It provided for the withdrawal of prohibition on options in securities. The last decade, beginning the year 2000, saw the lifting of ban of futures trading in many commodities. Around the same period, national electronic commodity exchanges were also set up.

Derivatives Market at NSE

The derivatives trading on the exchange commenced with S&P CNX Nifty Index futures on June 12, 2000. The trading in index options commenced on June 4, 2001 and trading in options on individual securities commenced on July 2, 2001. Single stock futures were launched on November 9, 2001. The index futures and options contract on NSE are based on S&P CNX Nifty Index.

Trading Mechanism

The futures and options trading system of NSE, called NEAT-F&O trading system, provides a fully automated screen based trading for Nifty futures & options and stock futures & options on a nationwide basis and an online monitoring and surveillance mechanism. It supports an anonymous order driven market which provides complete transparency of trading operations and operates on strict price time priority. It is similar to that of trading of equities in the Cash Market (CM) segment. The NEAT-F&O trading system is accessed by two types of users.

The Trading Members(TM) have access to functions such as order entry, order matching, and order and trade management. It provides tremendous flexibility to users in terms of kinds of orders that can be placed on the system. Various conditions like Good-till-Day, Good-till- Cancelled, Good-till-Date, Immediate or Cancel, Limit/Market price, Stop loss, etc. can be built into an order.

The Clearing Members (CM) uses the trader workstation for the purpose of monitoring the trading member(s) for whom they clear the trades. Additionally, they can enter and set limits to positions, which a trading member can take.



Introduction to Forwards, Futures and Options

Futures Markets

Pricing of Forwards and Futures

Hedging using Futures

Interest Rate Futures

Swaps

Option Markets

Option Trading Strategies

Option Pricing

Option Greeks

Exotic Options

Real Options

Credit Derivatives

Derivative Mishaps and Learnings

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