Market for Derivatives

Market for Derivatives

• Derivatives are financial instruments with values derived from underlying assets like equities, forex, or indices.
• Transactions involve contracts where parties agree to pay each other based on asset values at a specific time.
• Regulatory definition includes securities derived from debt instruments, contracts for differences, and others.
• Common types of derivatives include futures, forwards, options, and swaps.

How Derivatives Work

• Investors utilize margin money, a fraction of the asset's total value, to take leveraged positions in derivatives.
• Margin amounts are set by stock exchanges and can fluctuate over time.
• If the underlying asset's price increases, investors profit; if it decreases, they risk losing the entire margin or more.
• Example: Buying a gold futures contract valued at Rs. 11 lac requires only a 4% margin (Rs. 44,000), instead of the full amount, highlighting potential for both profit and loss.
• Misunderstanding of risk often leads investors to over-leverage, resulting in significant losses when prices drop.

Margin System

• The National Securities Clearing Corporation (NSCCL) manages risk through an online monitoring and margining system.
• The Standard Portfolio Analysis of Risk (SPAN) system is employed for margin calculations.
• Position monitoring occurs intraday, ensuring timely assessment of risks across portfolios.

Risks Involved in Derivatives

• Participation in the derivatives market necessitates a clear understanding of the risks, as losses can exceed initial investments.
• Derivatives should not be treated as investments since they are not considered an asset class.
• Investors retain liability for the remaining value of the underlying asset at contract expiration, leading to substantial profits or losses with sharp market movements.

Participation in Derivatives

• Individuals, brokers, and corporations can engage in the derivatives market, provided they have a tolerance for risk.