DERIVATIVES ANALYSIS
Derivative is a financial security with a value that is reliant upon or derived from, an underlying asset or group of assets. Common derivatives include Futures Contracts, Forwards, Options and Swaps. Exchange-traded derivatives like Futures or Stock Options are standardized and eliminate/reduce many of the risks of over-the-counter derivatives.
Futures
Futures Contract is a legally binding agreement to buy or sell an underlying security at a future date at a pre-determined price. The Contract is standardized in terms of Quantity, Quality, Delivery Time and Place for settlement at a future date (In case of Equity/ Index Futures, this would mean the Lot Size). Both parties entering into such an agreement are obligated to complete the contract at the end of the contract period with the delivery of cash/stock.
Options
Options Contract is similar to a futures contract in that it is an agreement between two parties to buy or sell an asset at a predetermined future date for a specific price. The key difference between options and futures is that, with an option, the buyer is not obliged to exercise their agreement to buy or sell. It is an opportunity only, not an obligation-futures are obligations. As with futures, options may be used to hedge or speculate on the price of the underlying asset.
Advantages of Derivatives
Derivatives can be a useful tool for a trader as well as for an investor. It provides a way to lock in the price, hedge against unfavourable movements in rates, and mitigate the risks often for a limited cost. Besides, derivatives can often be purchased on the margin that is, with borrowed funds which makes them even less expensive.
More about Future and Option Segment
1What is the F&O segment?
Apart from a cash market where shares are bought and sold, the exchanges have a segment where futures and options on shares and indices like Nifty or Bank Nifty can be purchased and sold.
2What is the future and what is an option contract?
A futures contract allows you to Buy or Sell an underlying Stock or Index at a pre-set price for delivery on a future date. Options are of two types Call and Put.
Call Option gives a Buyer the right to purchase an underlying stock or index at a pre-set price during a contract’s liquid life which could be a month or also a week in the case of Nifty or Bank Nifty. A Call Seller has the obligation to give delivery to the buyer at the pre-set price even if the current market price is higher than the former.
Put Option lets a Buyer sell the share at a pre-set price during the contract life. A Put Seller has the obligation to buy underline from the buyer at a pre-set price even if CMP (Current Market Price) of the share is lower.
The Call and Put Buyer give the premium to the Seller whereas the Seller received a premium from the buyers.