Derivatives

Derivatives derive their value from an underlying asset, which can be categorized into the following types:

1️⃣ Equity-Based Assets 📊

• Stocks (e.g., Futures & Options on Reliance, TCS)
• Stock Indices (e.g., Nifty 50, Sensex)

2️⃣ Commodity-Based Assets 🌾⚡

• Metals (e.g., Gold, Silver, Copper)
• Energy (e.g., Crude Oil, Natural Gas)
• Agri-commodities (e.g., Wheat, Cotton, Sugar)

3️⃣ Currency-Based Assets 💱

• Foreign Exchange (Forex) (e.g., USD/INR, EUR/USD currency futures)

4️⃣ Interest Rate-Based Assets 📉📈

• Government Bonds & Treasury Bills (e.g., Interest Rate Swaps, Bond Futures)

5️⃣ Credit-Based Assets 🏦

• Credit Default Swaps (CDS) – Used for risk protection against loan defaults.

6️⃣ Crypto-Based Assets (Emerging) 🪙

• Bitcoin, Ethereum & Other Cryptos (e.g., Bitcoin Futures)

Derivatives can be classified into two types based on where they are traded:

1️⃣ Exchange-Traded Derivatives (ETDs) 🏛️

✅ Traded on regulated stock exchanges (e.g., NSE, BSE, CME).
✅ Standardized contracts (fixed contract size, expiry dates, margin requirements).
✅ Highly liquid & transparent with price discovery.
✅ Lower counterparty risk due to clearinghouse involvement.

🔹 Examples:

• Stock Futures & Options (e.g., Nifty 50 Futures, Reliance Options).
• Commodity Futures (e.g., Gold, Crude Oil Futures).
• Currency Futures (e.g., USD/INR Futures).

2️⃣ Over-the-Counter (OTC) Derivatives 🏦

✅ Privately traded between two parties (not on an exchange).
✅ Customized contracts (tailored to specific needs).
✅ Higher counterparty risk (risk of default).
✅ Less liquidity & transparency compared to ETDs.

🔹 Examples:

• • Interest Rate Swaps (IRS).
  • Forward Contracts (e.g., USD/INR Forward Contract).
  • Credit Default Swaps (CDS).

Trading in derivatives offers several advantages for investors, traders, and institutions.

1️⃣ Hedging Against Risk 🛡️

✅ Protects against price fluctuations in stocks, commodities, currencies, and interest rates.
✅ Example: A farmer can hedge against falling crop prices using commodity futures.

2️⃣ Leverage 📊

✅ Allows traders to control a large position with a small margin (initial investment).
✅ Example: Buying Nifty Futures requires only a fraction of the total contract value.

3️⃣ Speculation for Profits 💰

✅ Traders can profit from price movements without owning the underlying asset.
✅ Example: An investor can buy options to bet on stock price increases or decreases.

4️⃣ Arbitrage Opportunities 🔄

✅ Traders exploit price differences in different markets to earn risk-free profits.
✅ Example: Buying a stock in the cash market & selling in the futures market if there’s a price gap.

5️⃣ Liquidity & Market Efficiency 🚀

✅ High trading volumes ensure easy entry & exit for traders.
✅ Example: Stock index futures (Nifty, Sensex) are actively traded, ensuring liquidity.

6️⃣ Diversification 🌍

✅ Derivatives help investors spread risk across different asset classes (stocks, commodities, forex).
✅ Example: A portfolio with equity & commodity derivatives reduces overall risk.

A futures contract is a standardized agreement to buy or sell an underlying asset at a fixed price on a specific future date. These contracts are traded on exchanges like NSE, BSE, and MCX.

Key Features of Futures Contracts 🔑

✅ Standardized – Fixed contract size, expiry date, and settlement terms.
✅ Exchange-Traded – Reduces counterparty risk due to clearinghouse involvement.
✅ Leverage – Requires only a margin deposit (fraction of total value).
✅ Obligation to Buy/Sell – Unlike options, both buyer & seller must fulfill the contract.

• 1️⃣ Contract Size 📏

  ✅ The fixed quantity of the underlying asset in one futures contract.
  ✅ Example: Nifty 50 Futures = 1 lot = 75 units of the index.

  2️⃣ Expiry Date ⏳

  ✅ The pre-determined date when the contract expires.
  ✅ Most contracts have monthly expiry (e.g., last Thursday of the month for NSE).

  3️⃣ Margin Requirement 💰

  ✅ Initial Margin – Minimum amount needed to enter a trade (~10-20% of contract value).
  ✅ Maintenance Margin – Minimum balance required to keep the position open.

  4️⃣ Mark-to-Market (MTM) 🔄

  ✅ Daily profit/loss settlement based on price changes.
  ✅ Losses must be paid daily (margin call if balance falls below maintenance margin).

  5️⃣ Leverage ⚖️

  ✅ Allows traders to control large positions with small capital.
  ✅ Example: If margin is 10%, a ₹1 lakh contract can be traded with just ₹10,000.

  6️⃣ Lot Size 🎲

  ✅ The minimum tradable quantity of a futures contract.
  ✅ Example: Bank Nifty Futures lot size = 30 units.

  7️⃣ Open Interest (OI) 📈

  ✅ The total number of open (unsettled) contracts in the market.
  ✅ High OI indicates strong market participation.

  8️⃣ Hedging & Speculation 🎯

  ✅ Hedging: Reducing risk by taking an opposite futures position (e.g., farmer hedging wheat prices).
  ✅ Speculation: Betting on price movement to earn profits.

An options contract is a financial derivative that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a pre-determined price (strike price) before or on a specific date (expiry date).

Unlike futures, options provide flexibility—the buyer can choose whether to exercise the contract, while the seller is obligated if the buyer decides to exercise it.

Types of Options 📝

1️⃣ Call Option (Bullish) 📈 – Right to buy an asset at the strike price.
2️⃣ Put Option (Bearish) 📉 – Right to sell an asset at the strike price.

Key Features of Options 🔑

✅ No Obligation for Buyer – Only the seller (writer) has an obligation.
✅ Premium Payment 💰 – Buyers pay a premium to enter the contract.
✅ Leverage ⚖️ – Control a large position with a small upfront cost.
✅ Risk-Defined for Buyers – Buyers’ losses are limited to the premium paid, but sellers can have unlimited losses.

1️⃣ Underlying Asset Price 📈📉 – Call premiums rise if the asset price increases; Put premiums rise if the asset price drops.

2️⃣ Strike Price 🎯 – Options closer to the market price (In-the-Money) have higher premiums.

3️⃣ Time to Expiry ⏳ – More time = higher premium; value decreases as expiry nears (theta decay).

4️⃣ Volatility (IV) 🌊 – Higher volatility = higher premium for both Calls & Puts.

5️⃣ Interest Rates & Dividends 💰 – Higher interest rates increase Call prices & decrease Put prices. Dividends lower Call prices & increase Put prices.

India VIX (Volatility Index) is a measure of market volatility expectations over the next 30 days. It is often called the "Fear Index" because it indicates investor sentiment and risk perception in the market.

✅ Calculated based on Nifty 50 options data (Implied Volatility of OTM options).
✅ Higher VIX = More uncertainty & higher expected volatility.
✅ Lower VIX = Stability & lower expected volatility.

Interpretation of India VIX 📈📉

🔹 VIX ↑ (High Volatility) → Fear in the market, possible corrections.
🔹 VIX ↓ (Low Volatility) → Stability, possible bullish trend.

The Put-Call Ratio (PCR) is a sentiment indicator that helps analyze market direction based on the volume or open interest of Put vs. Call options.

How is PCR Calculated? 🔢

📌 PCR (Volume-Based) = Total Put Volume ÷ Total Call Volume
📌 PCR (Open Interest-Based) = Total Put OI ÷ Total Call OI

Interpreting PCR 📈📉

• Above 1: Bullish sentiment.
• Between 0.7 to 1: Neutral.
• Below 0.7: Bearish sentiment.

Open Interest (OI) refers to the total number of outstanding (unsettled) futures or options contracts in the market. It indicates market participation and liquidity.

How OI Works? 🔄

✅ OI Increases – New contracts are created (more traders entering).
✅ OI Decreases – Contracts are closed (traders exiting positions).
✅ OI Unchanged – No new positions; traders are just exchanging contracts.

Interpreting OI & Price Movements 📈📉

India VIX (Volatility Index) and Nifty 50 have an inverse relationship—meaning they usually move in opposite directions.

✅ India VIX ↑ (High Volatility) → Nifty 50 ↓

• Rising VIX signals higher uncertainty, fear, and possible market corrections.
• Traders hedge positions, leading to increased selling pressure.

✅ India VIX ↓ (Low Volatility) → Nifty 50 ↑

• Falling VIX signals market stability and investor confidence.
• More buying activity leads to bullish trends.