Derivatives are financial instruments whose value is based on an underlying asset such as a stock. They were introduced in India in 2000 and allow investors to trade capital markets without holding large quantities of the underlying asset. Derivatives trading provides benefits like leverage, hedging, arbitrage, and fixed income opportunities but it also carries risks from volatility in the underlying asset and open interest levels. Factors like open interest, trade volumes and liquidity, time to expiry, and put-call ratios must be considered when trading derivatives.

1. Derivatives
• Derivatives are financial instruments that derive
their value from an underlying asset. The
underlying assets can be equity, currency or a
commodity.
• During last 10 years the financial environment of
the country has witnessed an unprecedented
growth along with the high degree of uncertainty
and variability.
• Derivatives were introduced in the country in
June 2000.. During the year 2003, the government
has granted permission to start buying & selling in
commodity futures.

2. Benefits of Derivative Trading
Derivatives are those financial instruments which
provides the ample scope of trading in capital market
without holding a large quantity of stock i.e. without
high investment. Derivative instruments also protects
the portfolio of the investor by paying a small premium
amount. It gives the significant scope of making profits
with minimum amount of risk involved. The advantage
of derivative trading can be summarised as follows :
(1) Advantage of Leverage
2) Advantage of Hedging
(3) Advantage of Arbitrage
(4) Power to defer
(5) Power to earn Fixed Income

3. Stock Exchanges : A barometer of Economy
Stock exchange is a place of transacting business between the
authorised members of the exchange. No stock broker shall buy, sell or
deal in securities unless he holds a certificate granted by the Securities
and Exchange Board of India.
The main function of any stock exchange is to act as a medium of
transaction of securities from one hand to another freely, at a price
decided by the forces of demand and supply. The important economic
functions of a stock exchange are as follows :
1. Providing regular market place to transact securities and acting as
an intermediary between buyers and sellers.
2. Encouraging investment habit in the general public and thus
developing capital formation.
3. Creating a mechanism for continuous evaluation of the securities
and thus providing stability in the prices.
5. Providing historical data for the evaluation of market trend of the
security and performance of the company.

4. Trading in derivatives is highly risky unless it
is protected by certain strategy. The minimum
contract size and the market lot of derivative
trading are very high for a small investor to
deal in. the volatility of the underlying and the
premium/discount on the market price also
effects the future price. High open-interest on
a particular expiry date also increases the
volatility of the market. It is therefore required
to give close look on the various factors of
derivative trading
Trading

5. Open interest :
Open interest is the total number of future and
option contracts of a given security and on a given
day that have not been offset by an opposite future
or option transaction. Each open interest has a
buyer and a seller, but for calculation of open
interest, only one side of contract is counted. A high
open interest position in any security indicates
good invester's interest in that security thus
ensures good liquidity. The open interest of current
months are higher than the near or far month. this
position simply indicates that the investors in
derivative market are generally interested in short-
term gain rather than long-term profitability

6. Put-Call Ratio :
The put-call ratio is a indicator of
market sentiment. It is the ratio of
number of puts to the number of calls in
the market on a given day.

7. Time to expiry :
Time to expiry is the another factor of
consideration in case of derivative trading. In
India, the derivatives are traded for three
months trading cycle i.e. current near and far
months. In practice, the most active
instruments are of current months and the
trades for the far month are very rare. In fact,
the majority of the volumes are concentrated
on the current and near month contracts.

8. Trade Volumes and Liquidity :
The strength of the scrip is
dependent upon the volume of
trade. Higher volume gives higher
liquidity and ill-liquid stocks are
generally traded in low volumes.

9. Clearing & Settlement (Derivatives)
National Securities Clearing Corporation Limited
(NSCCL) is the clearing and settlement agency for
all deals executed on the Derivatives (Futures &
Options) segment. NSCCL acts as legal counter-
party to all deals on NSE's F&O segment and
guarantees settlement.
A Clearing Member (CM) of NSCCL has the
responsibility of clearing and settlement of all deals
executed by Trading Members (TM) on NSE, who
clear and settle such deals through them.

10. Clearing Members
A Clearing Member (CM) of NSCCL has the
responsibility of clearing and settlement of all deals
executed by Trading Members (TM) on NSE, who
clear and settle such deals through them. Primarily,
the CM performs the following functions:
1.Clearing – Computing obligations of all his TM's
i.e. determining positions to settle.
2.Settlement - Performing actual settlement. Only
funds settlement is allowed at present in Index as
well as Stock futures and options contracts
3.Risk Management – Setting position limits based
on upfront deposits / margins for each TM and
monitoring positions on a continuous basis

11. Types of Clearing Members
Trading Member Clearing Member (TM-CM)
A Clearing Member who is also a TM. Such CMs may clear and
settle their own proprietary trades, their clients’ trades as well as
trades of other TM’s
Professional Clearing Member (PCM)
A CM who is not a TM. Typically banks or custodians could
become a PCM and clear and settle for TM’s.
Self Clearing Member (SCM)
A Clearing Member who is also a TM. Such CMs may clear and
settle only their own proprietary trades and their clients’ trades but
cannot clear and settle trades of other TM’s.

12. Clearing Mechanism
A Clearing Member's open position calculation is
arrived by aggregating the open position of all the
Trading Members (TM) and all custodial participants
clearing through him. A TM's open position in turn
includes his proprietary open position and clients’ open
positions.

13. Proprietary / Clients’ Open Position
While entering orders on the trading system,
TMs are required to identify them as proprietary
(if they are own trades) or client (if entered on
behalf of clients) through 'Pro / Client' indicator
provided in the order entry screen. The
proprietary positions are calculated on net
basis (buy - sell) and client positions are
calculated on gross of net positions of each
client i.e., a buy trade is off-set by a sell trade
and a sell trade is off-set by a buy trade.

14. Corporate Actions Adjustment
The basis for any adjustment for corporate
actions shall be such that the value of the position
of the market participants, on the cum and ex-
dates for the corporate action, shall continue to
remain the same as far as possible. This will
facilitate in retaining the relative status of
positions viz. in-the-money, at-the-money and
out-of-money. This will also address issues
related to exercise and assignments.

15. Corporate Actions to be adjusted
The corporate actions may be broadly classified under
stock benefits and cash benefits.
The various stock benefits declared by the issuer of
capital are:
* Bonus
* Rights
* Merger / De-merger
* Amalgamation
* Splits
* Consolidations

16. Clearing Banks
NSCCL has empanelled 11 clearing banks namely
Canara Bank, HDFC Bank, IndusInd Bank, ICICI Bank,
UTI Bank, Bank of India, IDBI Bank, Hongkong &
Shanghai Banking Corporation Ltd., Standard Chartered
Bank, Kotak Mahindra Bank and Union Bank of India.
Every Clearing Member is required to maintain and
operate a clearing account with any one of the
empanelled clearing banks at the designated clearing
bank branches. The clearing account is to be used
exclusively for clearing & settlement operations.