Derivatives Market Basics
Derivatives Market Basics
This domain tests the language and mechanics of exchange-traded and OTC derivatives, especially the Indian F&O market. Expect questions on payoffs, contract design, participant roles and the difference between rights and obligations.
Core concepts
- A derivative’s value depends on an underlying - index, stock, currency or rate. A forward is OTC and customised, with counterparty risk. A futures contract is standardised, exchange-traded and novated to the clearing corporation.
- A futures position carries both upside and downside; daily mark-to-market converts the gain or loss into cash. An option buyer pays a premium and has a right, not an obligation; the writer receives premium and carries the obligation.
- Index options in India are European-style and cash-settled. Single-stock futures and options are settled by delivery of shares, so a dealer must plan funding and demat delivery.
- Lot size, tick size, expiry and settlement price are fixed by the exchange under SEBI rules. Contract value is not margin; margin is a performance deposit.
Worked example
A dealer buys one Nifty call at a strike of 22,000 for a premium of 150; assume lot size 25. At expiry the index is 22,400. Intrinsic value = 22,400 − 22,000 = 400. Net payoff per unit = 400 − 150 = 250; total = 250 × 25 = ₹6,250 before costs. Break-even is 22,150. If the index ends at 22,100, the option expires worthless and the loss is the premium paid: 150 × 25 = ₹3,750.
Traps that cost marks
- Do not confuse option premium with margin; premium is the price of the right, margin is collateral.
- Do not apply futures payoffs to options without deducting premium.
- Do not assume stock derivatives are cash-settled; physical settlement creates delivery obligations.
- Read whether a question asks for payoff, profit or return on margin.