Derivative

A derivative is a financial instrument whose value is based on (derived from) the price of an underlying asset. The underlying can be a stock (equity derivative), an index (index derivative), a Commodity (commodity derivative), a currency pair (currency derivative), or an interest rate. Futures and options (Call Option) are the two most common derivative types.

In India, the derivatives market on the NSE is one of the largest in the world by number of contracts traded. The NSE F&O segment trades equity derivatives (futures and options on 200+ individual stocks), index derivatives (Nifty 50, Bank Nifty, Nifty Financial Services, Nifty Midcap Select), and currency derivatives. The MCX handles commodity derivatives.

Derivatives serve three primary purposes: hedging (reducing risk — a portfolio manager sells Nifty futures to protect against a market decline), speculation (taking leveraged directional bets — buying Nifty call options for 10-100x potential returns), and Arbitrage (exploiting price differences between cash and futures markets). In reality, speculation dominates Indian derivative volumes — the daily notional turnover in options alone exceeds Rs 100 lakh crore.

Key terms for derivative trading include: lot size (minimum tradeable quantity — Nifty is 25 units), margin (upfront deposit required, typically 12-20% of contract value for futures), premium (price paid for options), expiry (date when the contract settles — weekly for index options, monthly for stock options), and Greeks (sensitivity measures for options pricing).

SEBI has progressively tightened derivative regulations due to retail losses. The 2024 reforms increased minimum lot values to Rs 5-10 lakh, reduced weekly expiries to one per exchange, mandated upfront premium collection, and increased margin requirements during expiry week. These changes aim to curb speculative excess while preserving the hedging and price discovery functions of the derivative market.