The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices.

or reference rate). commodity or any other asset. The underlying asset can be equity. called bases (underlying asset. index. .Derivative is a product whose value is derived from the value of one or more basic variables. in a contractual manner. forex.

the derivatives market has seen a phenomenal growth. Marked improvement in communication facilities and sharp decline in their costs.Over the last three decades. Some of the factors driving the growth of financial derivatives are: 1. . A large variety of derivative contracts have been launched at exchanges across the world. 3. 2. Increased volatility in asset prices in financial markets. Increased integration of national financial markets with the international markets.

4. Development of more sophisticated risk management tools. Innovations in the derivatives markets. which optimally combine the risks and returns over a large number of financial assets leading to higher returns. reduced risk as well as transactions costs as compared to individual financial assets . and 5. providing economic agents a wider choice of risk management strategies.

options and swaps. futures.` ` Derivative contracts have several variants. We take a brief look at various derivatives contracts that have come to be used. The most common variants are forwards. Forwards Futures .

` ` ` ` ` ` Options Warrants LEAPS Baskets Swaps Swaptions .

hedgers.and arbitrageurs trade in the derivatives market .The following three broad categories of participants . speculators.

More specifically. A stock index represents the change in value of a set of stocks which constitute the index.An index is a number which measures the change in a set of values over a period of time. a stock index number is the current relative value of a weighted average of the prices of a pre-defined group of equities. .

the observed prices yield contaminated information and actually worsen an index. Hence. there is little to gain by diversifying beyond a point. A well diversified index is more representative of the market/economy. If the stock is illiquid. Going from 10 stocks to 20 stocks gives a sharp reduction in risk. The more serious problem lies in the stocks that we take into an index when it is broadened.A good index is a trade-off between diversification and liquidity. However there are diminishing returns to diversification. . Going from 50 stocks to 100 stocks gives very little reduction in risk. Going beyond 100 stocks gives almost zero reduction in risk.

major indices in the world like the S&P 500 and the FTSE-100 have shifted to a new method of index calculation called the "Free float" method. Recently. each stock in the index affects the index value in proportion to the market value of all shares outstanding. .Most of the commonly followed stock market indexes are of the following two types: Market capitalization weighted index or price weighted index. In a market capitalization weighted index. Indexes can also be equally weighted. A price weighted index is one that gives a weight to each stock that is proportional to its stock price.

It should be professionally maintained. It should capture the behaviour of a large variety of different portfolios in the market.A good market index should have three attributes: 1. . 2. The stocks included in the index should be highly liquid. 3.

` ` ` Index derivatives Index funds Exchange Traded Funds .

National Securities Clearing Corporation Limited (NSCCL) undertakes clearing and settlement of all trades executed on the futures and options (F&O) segment of the NSE. It also acts as legal counterparty to all trades on the F&O segment and guarantees their financial settlement. .

the rules and regulations framed there under and the rules and bye±laws of stock exchanges.The trading of derivatives is governed by the provisions contained in the SC(R)A. the SEBI Act. .

in accordance with the rules and bye±laws of such stock exchanges.³Derivative´ is defined to include: 1. A contract which derives its value from the prices. share. risk instrument or contract for differences or any other form of security. or index of prices. of underlying securities. A security derived from a debt instrument. contracts in derivative shall be legal and valid if such contracts are: 3. 2. loan whether secured or unsecured. Section 18A provides that notwithstanding anything contained in any other law for the time being in force. Traded on a recognized stock exchange 4. Settled on the clearing house of the recognized stock exchange. .


1992 provides for establishment of Securities and Exchange Board of India(SEBI) with statutory powers for (a) protecting the interests of investors in securities (b) promoting the development of the securities market and (c) regulating the securities market. in addition to all intermediaries and persons associated with securities market. .` SEBI Act. In particular. Its regulatory jurisdiction extends over corporates in the issuance of capital and transfer of securities.SEBI has been obligated to perform the aforesaid functions by such measuresas it thinks fit. it has powers for: regulating the business in stock exchanges and any other securities markets.

` ` ` ` ` registering and regulating the working of stock brokers. prohibiting fraudulent and unfair trade practices. undertaking inspection. as may be delegated to it by the Central Government. sub±brokers etc. conducting inquiries and audits of the stock exchanges. performing such functions and exercising according to Securities Contracts (Regulation) Act. 1956. calling for information from. promoting and regulating self-regulatory organizations. mutual funds and other persons associated with the securities market and intermediaries and self±regulatory organizations in the securities market. .

member committee under the Chairmanship of Dr.SEBI set up a 24. L. C. Gupta to develop the appropriate regulatory framework for derivatives trading in India. .

` ` Taxation of Profit/Loss on derivative transaction in securities Securities transaction tax on derivatives transactions .