Decoding Derivatives

Uploaded by : DreamGains Financials, Posted on : 23 Sep 2015


  • Derivatives have no independent value. Its value is derived from some other asset, which is called the “underlying asset”.
  • The underlying asset can be an index, a stock, a commodity, a bullion item or a currency. For example, derivatives of ITC shares will derive its value from the current share price of ITC.
  • The underlying asset could be index, stock, commodities bullion or currency.
  • Derivative contract is priced separately based on the underlying asset
  • The contract is traded not the underlying asset.
  • It acts as a good hedging tool against price volatility
  • You can take a high exposure on a stock or security by paying a small margin.
  • EXAMPLE: If the stocks are priced at Rs 10 lakh and you have only Rs 2 lakhs in hand, this product will still help you take a position.
  • It offers huge time leverage, which is a big plus for traders who do margin trading.
  • You can hold the position for 3 months. Normal margin product- 1 day, E-Margin product T+2 days

Types of Derivatives

  1. Futures: The owner has the obligation to buy or sell a contract at a pre-defined time and price. Conditions are standardised
  2. Forward: The owner has the obligation to buy or sell a contract at a pre-defined time and price. Conditions are customised between buyer and seller
  3. Option: The owner has the option to buy or sell something at a pre-defined price and time
  4. Swap: It is an agreement of barter or exchange of sequence of cash flows


  • It is a contract to buy /sell pre-defined quantities of an instrument at a specified price and time
  • Future contract has standardised conditions such as price, quantity and time
  • The owner of the contract has the obligation to buy or sell in future
  • Price is determined by supply and demand factors in secondary market
  • Index futures was the financial derivative launched in India
  • Every contract expires on last Thursday of the expiry month

Terminologies used in Futures


  • Spot Price: the trading price of the asset in the spot market
  • Future price: the price of future contracts in futures market
  • Contract Cycle: Validity period for trading in contracts
  • Contract Size: Amount of the asset to be delivered in specified time
  • Expiry date: The date on which validity of contract ends
  • Initial Margin: Amount to be deposited in margin account to start trading
  • Maintenance Margin: Minimum amount to be maintained for trading
  • Cost of Carry: Storage cost plus interest paid to finance the asset
  • Mark to Market: Adjustments (Profit or Loss) made to investor’s margin account based on future closing price

Types of Futures Contracts

In terms of Underlying Asset

  • Index Futures
  • Stock Futures

In terms of Expiry

  • Near Month
  • Next Month
  • Far Month



  • The owner has an option to buy or sell the contract at a pre-defined price
  • Purchaser of option has to pay something for this contract – in form of a premium.
  • You can sell/write options and receive an option premium from the buyer.
  • A seller is obliged to sell/buy an asset if the buyer exercises it on him.

Types of Options

  • CALL Option- Right (not an obligation) to BUY the contract
  • PUT Option- Right (not an obligation) to SELL the contract
  • Index Options – An Index is the underlying asset.
  • Stock Options – Stocks act as the underlying asset.

Terminologies used in Options


Please refer our separate blog dedicated on this topic here.


Difference between Futures & Options

  • Futures and unlimited profit or loss potential.
  • Options have limited risk and unlimited profit potential. (Only applicable to Long positions)