Detailed Explanation of Derivatives, Futures, Markets, Currencies, and Commodities
1. Derivatives
A derivative is a financial instrument whose value is derived from an underlying asset. The underlying asset can be stocks, bonds, commodities, currencies, interest rates, or market indices.
Types of Derivatives
Futures – A contract to buy/sell an asset at a predetermined price on a specific future date.
Options – The right (but not obligation) to buy/sell an asset at a predetermined price before or on the expiration date.
Forwards – Similar to futures but traded over the counter (OTC) instead of on an exchange.
Swaps – Agreements to exchange cash flows or liabilities over a period of time.
Example of Derivatives
A wheat farmer enters into a wheat futures contract to sell 100 quintals at ₹2,000 per quintal in six months. If the price falls to ₹1,800, the farmer still sells at ₹2,000, protecting himself from losses.
2. Futures Contracts
Futures in Indian Markets: A Detailed Explanation (Updated with Nifty 50 at 23,800)
What are Futures?
Futures contracts are agreements to buy or sell an underlying asset at a predetermined price on a specific future date. In India, futures trading is conducted on exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
Futures contracts are available for:
Stock Futures (e.g., Reliance Industries, TCS)
Index Futures (e.g., Nifty 50, Bank Nifty)
Commodity Futures (e.g., Gold, Silver, Crude Oil)
Currency Futures (e.g., USD/INR)
How Futures Work?
A futures contract allows traders to speculate on the price movement of an asset without owning it. The two main participants in a futures market are:
Buyer (Long Position): Expects the price of the asset to increase.
Seller (Short Position): Expects the price of the asset to decrease.
Each futures contract has:
Expiry Date: Usually the last Thursday of the month.
Lot Size: The minimum quantity that must be traded (e.g., Nifty 50 Futures have a lot size of 50).
Margin Requirement: Traders must deposit an initial margin and maintain a maintenance margin.
Examples of Futures Trading in India
Example 1: Nifty 50 Futures (Updated to 23,800)
A trader expects Nifty 50 Index, currently at ₹23,800, to rise.
The lot size of Nifty Futures is 50 units.
The trader buys 1 lot of Nifty futures at ₹23,800.
Possible Outcomes at Expiry:
If Nifty 50 rises to ₹24,000:
Profit = (24,000 - 23,800) × 50 = ₹10,000If Nifty 50 falls to ₹23,600:
Loss = (23,800 - 23,600) × 50 = ₹10,000
Example 2: Stock Futures (TCS)
Imagine a trader expects Tata Consultancy Services (TCS) stock to rise. The current market price of TCS is ₹3,500, and its futures contract trades at ₹3,520.
The lot size of TCS futures is 150 shares.
The trader buys 1 lot of TCS futures at ₹3,520.
Possible Outcomes at Expiry:
If TCS stock rises to ₹3,600:
Profit = (3,600 - 3,520) × 150 = ₹12,000If TCS stock falls to ₹3,400:
Loss = (3,520 - 3,400) × 150 = ₹18,000
3.Options Trading: An Overview
Options are derivative contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset (such as stocks, indices, or commodities) at a predetermined price (strike price) within a specified period.
Types of Options
Call Option – Gives the buyer the right to buy the underlying asset at a predetermined price.
Put Option – Gives the buyer the right to sell the underlying asset at a predetermined price.
Basic Terminology
Strike Price: The price at which the option holder can buy/sell the asset.
Premium: The cost paid by the buyer to the seller to acquire the option.
Expiry Date: The date on which the option contract expires.
ITM (In the Money): When exercising the option results in a profit.
ATM (At the Money): When the current price is equal to the strike price.
OTM (Out of the Money): When exercising the option results in a loss.
Example 1: Nifty Trading at 23,800
Let’s assume Nifty 50 Index is trading at 23,800, and you expect the market to go up.
Call Option Example (Bullish View)
You buy a Nifty 23,800 Call Option at a premium of ₹150.
If Nifty goes up to 24,200, the option gains value.
The profit per lot (1 lot = 50 units) would be:
Intrinsic value = 24,200 - 23,800 = ₹400
Net profit = (400 - 150) × 50 = ₹12,500.
If Nifty falls to 23,500, the option expires worthless, and you lose ₹150 × 50 = ₹7,500.
Put Option Example (Bearish View)
You buy a Nifty 23,800 Put Option at a premium of ₹120.
If Nifty falls to 23,400, the profit per lot would be:
Intrinsic value = 23,800 - 23,400 = ₹400
Net profit = (400 - 120) × 50 = ₹14,000.
If Nifty rises above 23,800, the put option expires worthless, and you lose ₹120 × 50 = ₹6,000.
Example 2: Reliance Trading at ₹1250
Let’s assume Reliance is trading at ₹1250, and you are trading options on it.
Call Option Example
You buy a Reliance 1250 CE (Call Option) at ₹30.
If Reliance moves to ₹1300, your profit:
Intrinsic value = 1300 - 1250 = ₹50
Net profit = (50 - 30) × Lot Size (250) = ₹5,000.
If Reliance falls below 1250, you lose ₹30 × 250 = ₹7,500.
Put Option Example
You buy a Reliance 1250 PE (Put Option) at ₹25.
If Reliance falls to ₹1200, your profit:
Intrinsic value = 1250 - 1200 = ₹50
Net profit = (50 - 25) × 250 = ₹6,250.
If Reliance rises, the put option expires worthless, and you lose ₹6,250.
Popular Options Trading Strategies
1. Covered Call (For Moderate Bullish View)
Hold the stock and sell a call option.
Example: You own 100 shares of Reliance at ₹1250 and sell a 1300 CE for ₹30.
If Reliance moves above 1300, you miss extra gains but keep the ₹30 premium.
2. Protective Put (For Hedging)
Buy a stock and also buy a put option for protection.
Example: Buy Reliance at ₹1250 and buy ₹1200 PE for ₹20.
If the stock crashes, the put option limits losses.
3. Straddle (For Volatile Markets)
Buy both a call and put option at the same strike price.
Example: Buy Nifty 23,800 CE at ₹150 and 23,800 PE at ₹140.
If Nifty moves significantly, one side will give big profit.
4. Iron Condor (For Range-bound Markets)
Sell an OTM Call and OTM Put while buying further OTM Call & Put to limit risk.
Best for when you expect the market to stay within a range.
Conclusion
Buy Calls if you expect the market to rise.
Buy Puts if you expect the market to fall.
Use Strategies to maximize profit while managing risk.
4. Currencies (Forex Market)
Foreign Exchange (Forex) Market is where currencies are traded globally. It is the largest and most liquid market.
How Currency Trading Works?
Currencies are traded in pairs (e.g., USD/INR, EUR/USD).
If you expect INR to weaken against USD, you buy USD and sell INR.
If INR strengthens, you sell USD and buy INR to profit.
Example of Currency Trading
Suppose USD/INR = 83.00 today.
You buy $1,000 (spend ₹83,000).
If USD/INR rises to 85.00, your $1,000 is now worth ₹85,000.
Profit = ₹2,000.
5. Commodities
A commodity is a raw material that can be traded, such as metals, agricultural products, and energy sources.
Types of Commodities
Metals – Gold, Silver, Copper, Aluminum.
Energy – Crude Oil, Natural Gas.
Agricultural – Wheat, Sugar, Cotton, Coffee.
Example of Commodity Trading
A gold trader buys a gold futures contract at ₹60,000 per 10g.
If gold prices rise to ₹62,000, he makes a ₹2,000 profit.
If prices fall to ₹58,000, he incurs a ₹2,000 loss.
Conclusion
Concept Definition Example Derivatives Financial instruments whose value depends on an underlying assetStock options, currency swapsFuturesA contract to buy/sell an asset at a fixed price on a future dateGold futures, Nifty 50 futuresMarketsPlaces where assets are bought and soldNSE, Forex marketCurrenciesTrading of global currenciesUSD/INR, EUR/USDCommoditiesTrading of physical goodsGold, Crude Oil, Wheat
This explanation provides a solid understanding of these financial instruments with real-world examples. Let me know if you need further details! 🚀