What is Derivatives Market ?

Basic of Derivatives Market

Derivative are product and contracts whose value is derived from another asset know as underling asset. Derivatives or securities in the form of a contract between two or more institution to buy or sell an underlying asset in the future. In this contract, investors make profits by predicting the future price of the underlying assets.

Derivatives products are based on a wide range of a underlying assets.

Here are some examples: –

• Metal: – Gold, Silver, Copper, Zinc etc.
• Energy: – Oil, Coal, Crude oil, Gas etc.
• Agri Commodities: – Wheat, Coffee, Cotton, Grance etc.
• Financial assets: – Share, Bonds and Foreign Exchange.

Some factors that impact the Derivatives Market Globally. (Derivatives Market )

In the last few decades, tremendous growth has been seen in the Derivatives Market. Many Derivatives Markets have been launched in exchange all over the world, Some factors due to which Financial Derivatives growth.

• Increase in price volatility of underlying assets.
• Unifying financial market globally.
• Using new technology and communication methods helps reduce transaction coast.
• Enhance market participants better understanding of risk management tools and manage risk.
•   Continuous innovation and application of products in the Derivatives market.

Indian Derivatives Market

Introducing Derivative Market in India, SEBI formed a committee of 24 members under the chairmanship of L.C. Gupta. The committee made recommendation in 1998 that Derivatives should be included as securities so that securities could be traded in traded like Derivative.

After that SEBI also formed a committee in 1998 under the chairmanship of J.R. Verma, to recommend risk prevention measure in India. This committee submitted a report. As explained below Operational details of merging system, Membership details and net worth criteria, Deposit requirement and real time monitoring of positions requirement, charging initial margin.

Exchange traded funds started in India in 2000, SEBI allows NSE or BSE to launch Equity Derivatives Segment. SEBI allows index future trading based on Nifty50 or Sensex.

After that, index options and individual stocks options were allowed in 2001. Future and individual stocks started trading in 2001.

Products in the Derivatives Market

• Forward: – Forward contract and agreement are made between two parties agree to buy or sell an underlying asset at a future date at a particular price that at decided at the time of making the contract. Forward contract is not traded on exchange; hence counterparty risk and liquidity risk also remain. In Forward contract, terms and conditions, price and quantity are all decided by negotiation. Forward contract is also known as Over the Counter Contract (OTC).
• Futures: – A future contract is similar to a forward contract in that it is traded through an organized and regulated exchange rather than negotiated between two parties. A future contract is a standardized contract that incudes a lot size, Expiry dates etc.so that it can be traded on an exchange. Future contracts were announced to reduce risk of forward contract.
• Option: – An option contract gives the buyers right to buy or sell the underlying assets at a specific expiration date and a specific price but does not provide an obligation. The buyer pays the premium and buy the rights, and the writer/seller of the option receive the premium by buying or selling the underlying assets with the obligation.
• SWAP: – A SWAP is an agreement between two parties to exchange cash in the future with a predetermined formula. It is not use for shares, it is used for debt securities like bonds, debentures. This is made to reduce the risk from volatility in interest rate and SWAP is basically an interest rate Derivatives.

Market Participants

There are three types of market participants in the Derivatives market: Hedger, Speculator or Trader, Arbitrators.

• Each person can pay a different role in different market condition.
• Hedger: – Hedge Derivatives are used to reduce the risk caused by changes in the price of underlying assets. Individual investors all use derivatives to hedge or reduce the risk of share, bonds, interest rate and commodities.
• Speculator or Trader: – Speculator build their positions in the underlying assets by predict future price movement. Buy if market goes up and sell when market goes down their transaction is very fast.
• Arbitrageurs: – Arbitrageurs is the advantage of taking differences in different market simultaneously. Therefore, we are able to reduce the risk in the market and can make profits from the changes in price movement.

Various risk faced by the participants in Derivatives market

It is very important for makes participants to understand the Derivative market. It is also important to know what risk we can face in the market.

1. Counterparty Risk
2. Liquidity Risk
3. Price Risk
4. Operational Risk (Documentation, improper execution, fraud etc.)

If you are a person with less tolerance or less experience and don’t have the ability to tolerate risk, you may want to consider whether such trading is suitable for him/her based on these parameters. Market participants who trade in Derivative should ensure that they carefully read the risk disclosure document provided by the Broker.

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