Derivatives Markets for NISM certification

Derivatives let people fix prices in advance, protect portfolios and take views on markets with limited money. This chapter introduces forwards, futures, options and swaps, how exchange-traded contracts are traded and settled, and how risk is controlled.

Operations & MarketsSeries XII63 MCQs4 lessons22 flashcards4 memory tricks

Practise Derivatives Markets free

What you'll learn

  1. What a derivative does
    Explain derivatives and their three uses.
  2. Forwards, futures, options and swaps
    Compare the four main types of derivatives.
  3. How exchange-traded derivatives work
    Describe contract specifications, settlement and margins.
  4. Using derivatives and reading the market
    Apply derivatives to hedging and read open interest, PCR and volatility.

Concepts explained

Call and put options

An option gives its buyer the right, not the obligation, to buy (call) or sell (put) at the strike price; the buyer pays a premium.

What it means

  • Buyer's maximum loss: the premium.
  • Seller's maximum gain: the premium.
  • Call is ITM when price > strike; put is ITM when price < strike.
Example 1: Call payoff
  • Strike 10,000, premium 100
  • Expiry 10,200: payoff 200
  • Net gain 200 − 100 = 100

Answer: Buyer gains 100

Example 2: Put payoff
  • Strike 500, premium 15
  • Expiry 470: payoff 30
  • Net gain 30 − 15 = 15

Answer: Buyer gains 15

Related terms

  • Moneyness: whether exercising an option would pay

Exam tip: Calls profit when prices rise, puts when prices fall.

Forwards versus futures

A future is a standardised, exchange-traded forward with daily settlement and a clearing guarantee.

What it means

  • Forwards: customised, OTC, counterparty risk, settled at the end.
  • Futures: standardised lots and expiries, exchange-traded, daily MTM, margins.
Example 1: Gold
  • Jeweller agrees privately with a supplier: forward
  • Jeweller buys gold futures on an exchange: future

Answer: Same idea, different structure

Related terms

  • Counterparty risk: risk the other side doesn't pay
Mark-to-market and margins

Gains and losses on futures are settled every day, and margins are collected upfront to cover potential losses.

What it means

  • Daily MTM settled in cash on T+1.
  • Initial margin covers a two-day risk estimate.
  • Exposure margin is a percentage of notional value.
  • Option sellers pay margins; buyers pay premium.
Example 1: Two days of MTM
  • Buy at 10,000, lot 75
  • Day 1: 9,950, loss ₹3,750
  • Day 2: 10,040, gain ₹6,750

Answer: Net gain ₹3,000 over two days

Related terms

  • Notional value: price × lot size
Open interest and sentiment indicators

Open interest, the put–call ratio and implied volatility help read activity and sentiment in derivative markets.

What it means

  • Open interest counts outstanding contracts on one side.
  • PCR compares puts with calls.
  • India VIX reflects expected Nifty volatility.
Example 1: Open interest
  • A buys 1 contract from B (new for both): OI = 1
  • C buys 1 contract from A (A closes): OI still 1

Answer: OI counts open positions, not trades

Related terms

  • Implied volatility: volatility implied by option prices

Memory tricks

Call vs put'Call to buy, put to sell': call your friend to buy the cricket ticket; put the ticket up for sale if the match looks boring.

Call = right to buy; put = right to sell.

Three participants'Hedger, speculator, arbitrageur = umbrella, gambler, bargain-hunter'.

Uses of derivatives.

Settlement at expiry'Index in cash, stocks in hand': index derivatives settle in cash; stock derivatives deliver shares.

Final settlement rules.

Option buyer's loss'Ticket cost is the most you lose': an option buyer can lose only the premium, like a movie ticket.

Option buyer's maximum loss.

Try 3 NISM-style questions

Q1. A call option gives the right to

  1. Sell the underlying at the strike price
  2. Receive interest
  3. Vote at the AGM
  4. Buy the underlying at the strike price
Show answer

Answer: (4) Buy the underlying at the strike price

Call = right to buy.

Q2. An investor holding ₹10 lakh of shares buys puts for ₹15,000. The market falls 10% and the puts pay ₹1,00,000. Her net loss is about

  1. ₹1,00,000
  2. ₹1,15,000
  3. Zero
  4. ₹15,000
Show answer

Answer: (4) ₹15,000

Share loss ₹1 lakh offset by put gain ₹1 lakh; cost is the premium.

Q3. Since October 2019, stock futures and options open at expiry are settled

  1. In cash only
  2. By rolling over automatically
  3. By physical delivery of the shares
  4. By SEBI auction
Show answer

Answer: (3) By physical delivery of the shares

SEBI mandated physical settlement for stock derivatives.

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