Derivatives

Derivatives are contracts whose value depends on an underlying asset such as a share, an index, a commodity, a currency or an interest rate. The market where they are traded is called the derivatives market.

Because their prices move with the underlying asset, derivatives are used to protect (hedge) existing holdings against price moves, or to take a view on where a price will go.

Derivatives in India

Derivatives trading in India has a long history, dating back to 1875, and exchange-traded equity derivatives in their current form began in 2000.

What derivatives are used for

• Hedging the price risk of shares you hold.
• Moving risk from those who want less of it to those willing to take more.
• Taking short-term positions without selling your shares.
• Arbitrage: using price differences between markets.

Types of derivatives

Forwards, futures and options are the most common. A future is an agreement to buy or sell an asset at a set price on a set date; futures trade on stock exchanges, while forwards are agreed privately (over the counter). An option gives the right, but not the obligation, to buy or sell at a set price.

Derivatives carry a high degree of risk and leverage can magnify losses. According to studies by SEBI, most individual traders in the equity futures and options segment incur net losses. Read the risk disclosure document before trading.