Different Types of Derivatives in India

When it comes to trading in the stock market, derivatives hold a prominent place. They are widely used for hedging risks, speculation, and managing portfolio exposure. Instead of directly owning an asset, derivatives allow traders to take positions based on the expected price movements of underlying instruments such as equities, commodities, currencies, or indices. But do you know that based on the needs, there are different types of derivatives that you can trade in?

So, if you are willing to start trading in different types of derivatives, then this guide is for you. Know their basics, pros and cons to make the right trading decisions. So, let us get started.

Understanding Derivatives

Before we explore the types of financial derivatives, let us quickly understand the meaning of derivatives here. A derivative is a financial contract whose value is derived from the performance of an underlying asset such as equities, commodities, currencies, or market indices. In India, standardized derivatives like futures and options are traded on regulated exchanges such as the NSE and BSE.

In derivatives trading, the trader does not own the asset directly but agrees to buy or sell it at a future date for a predetermined price. Derivatives are widely used for hedging risks, speculating on price movements, and enhancing portfolio strategies.

Now, with that being said, let us explore the different types of derivatives here.

Types of Derivatives

Derivatives are very important in the Indian financial market. It allows traders to gain the benefit of hedging, speculation, and risk management. There are 4 different types of derivatives that you should be aware of as follows:

1. Future Contract

A futures contract is a standardized derivative agreement. Under this, the trader agrees to buy or sell an underlying asset at a fixed price on a future date. They are used for hedging against a volatile market or speculation about future trends. These are marked-to-market daily and gains and losses are settled at the end of each trading day.

There is no physical delivery in most cases (except for some commodity contracts), but rather cash-settled positions. The use of leverage allows traders to control larger positions with a smaller margin amount. However, it also increases the risk of significant losses. 

Futures contracts must be settled at expiry. These are best suited for experienced traders who are looking to gain from short-term price fluctuations. Trading discipline is key here.

Pros of Futures Contracts

• High liquidity and ease of trade
• Transparent pricing and exchange regulation
• Effective tool for price hedging
• Enables both long and short positions
• Lower capital requirement due to leverage

Cons of Futures Contracts

• Leverage can magnify losses
• Requires margin maintenance and daily monitoring
• Involves significant risk for inexperienced traders
• No ownership of the underlying asset
• Contracts are time-bound with fixed expiries

2. Options Contract

An options contract is a financial derivative that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified time period. Unlike futures contracts, the buyer is not compelled to execute the trade if market conditions are unfavorable. This flexibility makes options a versatile tool for both hedging and speculation.

There are two types of options. A call option gives the right to buy. A put option gives the right to sell. The buyer pays a premium to gain this right. This limits the risk for the buyer to the premium paid. The seller here carries a higher level of risk. 

Options are used for both hedging risks and speculating on price movements. There is no actual ownership of the asset, but the right to trade it.

If you are looking for flexible strategies with controlled risk, these are the best. But you must evaluate the market and trends as well.

Pros of Options Contracts

• Limited loss for buyers (only the premium paid)
• Useful for hedging and speculation
• Lower capital requirement compared to futures
• Can benefit from market volatility
• No obligation to execute the trade

Cons of Options Contracts

• Difficult for beginners to understand
• Time decay can erode value quickly
• Unlimited risk exposure for sellers
• Requires precise market predictions
• Some contracts may have low liquidity

3. Forward Contract

A forward contract is a form of customized agreement. These are traded over-the-counter (OTC).  The agreement defines the price and a future date when the buy or sell transaction will happen. These are not traded on formal exchanges like NSE or BSE.

In other words, these are private contracts. Hence, terms such as price, quantity, and settlement date are mutually decided by the buyer and the seller. Forwards are mostly used by businesses or financial institutions for hedging against future price fluctuations.

There is no daily settlement or margin requirement. However, the absence of exchange regulation also increases counterparty risk. The lack of standardization makes them less accessible for retail traders.

Forward contracts are suitable for parties with specific hedging needs. Traders who prefer tailor-made terms over exchange-based standard contracts, usually use these.

Pros of Forward Contracts

• Custom terms and flexible structure
• Useful for hedging long-term exposure
• No margin requirements
• Can be tailored to match business needs
• No exchange fees or formal listing costs

Cons of Forward Contracts

• Higher counterparty risk
• Lack of liquidity and public pricing
• No regulatory oversight
• Difficult to exit or transfer before maturity
• Not suitable for small or retail traders

4. Swaps Contract

A swaps contract is a private agreement. Under this, two parties exchange cash flows or financial instruments over a specific period. These contracts are traded over-the-counter (OTC). You cannot trade them on exchanges like NSE or BSE. 

There are two types of swaps. These are interest rate swaps and currency swaps. 

In an interest rate swap, two parties agree to exchange fixed interest payments. This is done against floating interest payments based on a notional principal amount. In a currency swap, they exchange cash flows in different currencies. It is often used to manage foreign exchange risk.

Swaps are primarily used by large corporations and financial institutions. This is mainly for long-term risk management. There is no exchange of the underlying principal amount, but only the interest or currency payments agreed upon.

Swaps require a high level of financial expertise and strong creditworthiness. So retailers usually do not trade in these.

Pros of Swaps Contracts

• Customizable terms based on specific needs
• Helps manage interest rate or currency risks
• Useful for long-term financial planning
• No upfront cost in most cases
• Flexible settlement structure

Cons of Swaps Contracts

• High counterparty risk
• Lack of transparency and regulation
• Not available for retail trading
• Difficult to value and monitor
• Requires deep financial knowledge

Read Also: What is Swaps Derivatives?

Key Participants in the Derivatives Market

When it comes to derivatives, there are various people who trade in them. All of these people have different goals. This is why derivatives suit their portfolio. The most common participants in the derivatives market are as follows:

1. Hedgers: They use derivatives for protection against price fluctuations. These are the traders who trade in variety of assets
2. Speculators: These are the people who wish to gain from trades based on predictions. They perform price predictions based on trends. They accept higher risk in pursuit of higher returns.
3. Arbitrageurs: The aim here is to take advantage of price differences in different markets. These people aim to earn risk-free profits through simultaneous buy and sell trades.
4. Margin Traders: These use leverage to control large positions with small capital. While it boosts profit potential, it also increases risk.

These participants keep the derivatives market efficient, balanced, and liquid. Also, each of these are playing a crucial role in price discovery and risk management.

Read Also: Index Derivatives in India

How to Trade in Derivatives

When you are planning to trade in derivatives, there are certain steps to follow. The first thing is to have an account with the SEBI registered broker. Once you have that, here are the steps to know.

1. Open an Account

Register with a stockbroker who offers access to the derivatives segment. Ensure your account is enabled for F&O trading.

2. Understand Margin Requirements

Derivatives require you to maintain a margin. This is a percentage of the total contract value that must be paid upfront.

3. Choose a Derivative Instrument

Select between futures or options. It should be based on your risk appetite and strategy. If needed, seek expert guidance from your financial advisor.

4. Analyse the Market

Use technical analysis to predict price movements and manage risks effectively.

5. Place Your Order

Execute your trade through your broker’s trading platform. Monitor it closely and exit before or on expiry.

Read Also: What is Derivative Trading? Types, Examples, Pros & Cons Explained

Conclusion

Derivatives are among the most effective instruments for traders looking to manage risk, capitalize on short-term price movements, and build advanced trading strategies. Success in derivatives trading depends on clearly defining your trading objectives, choosing the right contract type, and maintaining strict risk management. Staying disciplined, analyzing market trends, and adjusting positions in real time are crucial for consistent performance. It is advised to consult a financial advisor before trading in derivatives.

Once you are ready, you can start your journey with Pocketful. It is a reliable and user-friendly platform that can help you while trading. So sign up today and get started.

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