A Derivative is a financial instrument whose value is 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 reduce many of the risks associated with over-the-counter Derivatives.
A Futures Contract is a binding agreement to Buy or Sell an underlying security at a predetermined price on a future date. The contract is standardized in terms of Quantity, Quality, Delivery Time, and place for settlement on a Future Date. Both parties are obligated to complete the contract at the end of the contract period with the delivery of cash or stock.
An Options Contract is similar to a Futures Contract, but the Buyer is not obliged to exercise their agreement to buy or sell. It is an opportunity, not an obligation. As with Futures, Options may be used to Hedge or Speculate on the price of the underlying asset.
Options are of two types - CALL and PUT.
CALL Option gives the Buyer the Right to Purchase an underlying Stock or Index at a pre-set price during the contract’s liquid life.
PUT Option gives the Buyer the Right to Sell an underlying Stock or Index at a pre-set price during the contract’s liquid life.
The CALL and PUT Buyers give a premium to the seller, whereas the seller receives a premium from the buyers.
Mote about Derivatives
Derivatives can be useful for traders and investors to lock in prices, hedge against unfavorable movements in rates, and mitigate risks for a limited cost. They can often be purchased on margin, making them even less expensive.
The F&O segment is a segment of the exchange where Futures and Options on Shares and Indices like Nifty or Bank Nifty can be purchased and sold.