The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities.

With Securities Laws (Second Amendment) Act,1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as:-

A Derivative includes: -

a. a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

b. a contract which derives its value from the prices, or index of prices, of underlying securities;

What are the types of Products in Derivatives

a) Index Futures

A futures contract is a standardized contract to buy or sell a specific security at a future date at an agreed price.

An index future is, as the name suggests, a future on the index i.e. the underlying is the index itself. There is no underlying security or a stock, which is to be delivered to fulfill the obligations as index futures are cash settled. As other derivatives, the contract derives its value from the underlying index. The underlying indices in this case will be the various eligible indices and as permitted by the Regulator from time to time.

b) Index Options

Options contract give its holder the right, but not the obligation, to buy or sell something on or before a specified date at a stated price. Generally index options are European Style. European Style options are those option contracts that can be exercised only on the expiration date. The underlying indices for index options are the various eligible indices and as permitted by the Regulator from time to time.

c) Stock Futures

A stock futures contract is a standardized contract to buy or sell a specific stock at a future date at an agreed price. A stock future is, as the name suggests, a future on a stock i.e. the underlying is a stock. The contract derives its value from the underlying stock. Single stock futures are cash settled.

d) Stock Options

Options on Individual Stocks are options contracts where the underlyings are individual stocks. Based on eligibility criteria and subject to the approval from the regulator, stocks are selected on which options are introduced. These contracts are cash settled and are American style. American Style options are those option contracts that can be exercised on or before the expiration date

e) Weekly Options

Equity Futures & Options were introduced in India having a maximum life of 3 months. These options expire on the last Thursday of the expiring month. There was a need felt in the market for options of shorter maturity. To cater to this need of the market participants BSE launched weekly options on September 13, 2004 on 4 stocks and the BSE Sensex.

Weekly options have the same characteristics as that of the Monthly Stock Options (stocks and indices) except that these options settle on Friday of every week. These options are introduced on Monday of every week and have a maturity of 2 weeks, expiring on Friday of the expiring week.

What is minimum contract size?

The Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian Markets should be pegged not below Rs. 2 Lakhs. Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 2 Lakh at the time of introducing the contract in the market. In February 2004, the Exchanges were advised to re-align the contracts sizes of existing derivative contracts to Rs. 2 Lakhs. Subsequently, the Exchanges were authorized to align the contracts sizes as and when required in line with the methodology prescribed by SEBI.

What is the lot size of a contract?

Lot size refers to number of underlying securities in one contract. The lot size is determined keeping in mind the minimum contract size requirement at the time of introduction of derivative contracts on a particular underlying.

For example, if shares of XYZ Ltd are quoted at Rs.1000 each and the minimum contract size is Rs.2 lakhs, then the lot size for that particular scrip stands to be 200000/1000 = 200 shares i.e. one contract in XYZ Ltd. covers 200 shares

What is the Contract Specification for Futures and Options?

The contract period for both Futures and Options are 1 month, 2 month and 3 months, each contract ending on the last Thursday of the contract month. If it is holiday, then the immediately preceding business day (Business day is a day during which the underlying stock market is open for trading). On the last trading day, the closing value of the underlying stock is the final settlement price of expiring futures contract. In Options, apart from normal contract period, there's also 1, 2 weeks contract periods.

What is the margining system in the derivative markets?

Two type of margins have been specified -

a) Initial Margin - Based on 99% VaR and worst case loss over a specified horizon, which depends on the time in which Mark to Market margin is collected.

b) Mark to Market Margin (MTM) - Collected in cash for all Futures contracts and adjusted against the available Liquid Networth for option positions. In the case of Futures Contracts MTM may be considered as Mark to Market Settlement.

What is the structure of Derivative Markets in India?

Derivative trading in India takes place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative Exchange/Segment function as a Self-Regulatory Organisation (SRO) and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment.