1. Derivatives

2. • Derivative is a financial instrument which derives its value from the
underlying asset.
• They are mostly used for hedging the risk which is associated with owning
the underlying asset. In simple terms they are contracts for future delivery of
assets and payment for them.
*Note: In India trading in derivative products takes place only in Futures and Options.
Derivative
Types of Derivatives
Forward Future Options Swap

3. Forwards
• It is a contractual agreement between two parties to buy/sell the
underlying asset at a pre-determined price on a pre-determined date.
• The terms and conditions of the contract size can be privately
negotiated.
• The parties to the contract are obligated to perform their part of the
contractual obligation
• The pre-determined date in a Forward contract is the expiry date
before which the parties to the contract have to fulfil their obligation.
• These are traded over-the-counter.

4. • Liquidity Risk: It is the ability of a market participant to convert his
position into cash. In forwards, the contracts are so customized that it
would become difficult to find a person who would be interested in the
same contracts which have been tailor made to suits someone’s specific
requirement.
• Counter-Party Risk: It is an economic loss due to the failure of a
counter party to fulfil his/her contractual obligation.
Drawback of Forwards

5. • It is a contractual agreement between two parties to buy/sell the
underlying asset at a pre-determined price on a pre-determined date.
• The terms and conditions of the contract are standardized and are
determined by the stock exchange.
• The parties to the contract are obligated to perform their part of the
contractual obligation.
• The pre-determined date in Futures contract is the expiry date before
which the parties to the contract have to fulfil their obligation.
• These are also called as Exchange Traded Forward contracts.
Futures

6. • Spot price is the price at which the underlying asset is available for
cash in the stock market.
• Futures contract price is the price at which the underlying asset will
available at a future date.
Futures Terminology
Future
Contract Price
Index Future Stock Future

7. Futures Terminology
Contract cycle:
• As the contracts are standardized by the exchange, they will decide over
what period the contracts will be available for trading.
• Contract cycles are for three months. Contracts available for trading are:
Near
Month
Next / Mid
Month
Far Month

8. Expiry Date:
• It is the date before which the parties to the contract fulfil their
contractual obligation.
• It is the date on which the contract ceases to exist.
• In equity derivatives, contracts will expire on last Thursday of every
month.
• As soon as the near month contract expires a new contract for the
far month is available for trading.

9. Determination of Currency Price
Contract Size/Lot Size:
• In the cash market shares
traded can be bought and sold in
single units.
• In futures market as the
minimum contract value for any
derivative contract has to be
Rs.5,00,000 depending upon the
current market price of an
index/stock the stock exchange
decides the minimum contract size
which has to be brought/sold.
Margin:
• It is the amount which the parties
to the futures contract have to pay to
the broker to enter into a futures
contract.
• Both the buyer and the seller of
the futures contract have to deposit
margin amount so as, to avoid counter
party risk.
• Margin amount depends upon the
volatility of the stock/index. More the
volatility higher the margin amount
and vice versa.

10. • Contract Value is the minimum contract value. For a derivative
contract, the value is Rs.5,00,000.
• Premium or Discount:
• If the price in the Futures market is more than the cash price of
underlying asset – then the Futures contract is said to be trading at
• Premium. If the price in the Futures market is less than the cash price
of underlying asset – then the Futures contract is said to trading at
Discount.
Particular Discount Premium
Cash Market 100 100
Futures Market 95 105

11. Settlement in Futures
• The settlement cycle for futures contract is on T+1 basis.
• The daily settlement price for futures contract will be – the closing
price of the Futures market price.
• The final settlement price for futures contract will be – the closing
price of the underlying asset on expiry.
Types of
Settlement
Daily
Settlement
Final
Settlement

12. Daily Settlement
• Daily settlement is done on MTM basis (Mark to Market)
• If the client is availing profit during the day, it shall get added to the
ledger value of the trading account
• If the client is incurring losses, then it shall get adjusted initially to the
initial margin of the position taken, and once the initial margin is
exhausted, then the loss shall get adjusted to the free cash available in
the trading account.
Types of Settlement

13. Futures
Daily Settlement
• Daily settlement is done on MTM
basis (Mark to Market)
• If the client is availing profit during
the day, it shall get added to the ledger
value of the trading account
• If the client is incurring losses, then
it shall get adjusted initially to the
initial margin of the position taken, and
once the initial margin is exhausted,
then the loss shall get adjusted to the
free cash available in the trading
account.
Final Settlement
• During final settlement,
which happens during expiry,
the spot price and the future
price shall be same, as the cost
of carry shall become zero, and
settlement happens on
prevailing spot price, the profit
and loss so made will get
adjusted with the ledger value
of the trading account.

14. Comparison of Futures with Delivery
Differentiation Futures Delivery
Nature Can go for long and as well as
for short position
Can only go for long position,
and can only sell if the client is
holding the position
Brokerage As same like intraday (i.e. on an
average 0.05%)
On an average (i.e. 0.50%)
Work basis Will work on the basis of Lots Will work on the basis of
number of shares
Margin Span margin is required to be
submitted on the basis of stock
to stock
100% capital is required ,while
margin shall be given on an
average 2 to 3 times on the
basis of haircut
Adjustment of profit and loss Profit and loss shall be adjusted
on Mark to Market basis
Profit and losses shall be
adjusted, once the client moves
out of the position

15. • Can get exposure on stocks.
• Carry forward is possible. You don’t have to square off on the same
day. It can be carried till the last Thursday of the month.
• Brokerage is charged as per intraday which is less than delivery.
• Short selling can be carried forward.
• Futures work on the basis of lots, which enhances the volume, for
which the client need not wait for the high price momentum.
• If the client holds the position, then everyday's profit will be added to
the ledger value of the account.
Advantages of Futures

16. • The only limitation in futures is Mark-to-Market settlement.
• If the client is holding the position and the client is incurring losses
then firstly it shall get adjusted to the initial margin of the client, and
further from the surplus amount available in the account.
Limitations in Futures

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