Derivatives

DEFINITION: Derivatives are financial instruments that derives its values from underlying assets. The underlying assets can be stocks, bonds, commodities etc. Derivatives can be of different types like futures, options, swaps, caps, collars etc. Most popular are futures and options. The phrase 'Derives its value from underlying assets' means, derivative on its own doesn't have any value. Its importance is by the virtue of its underlying assets. For ex. Infosys future has value due to the value of Infosys. FUTURES: These contracts are traded on the stock exchanges and it can change many hands before final settlement is made. There are two kinds of futures traded in the market- index futures and stock futures. An index is a set of numbers that represent a change over a period of time. A stock index is similarly a number that gives a relative measure of the stocks that constitute the index. Each stock will have a different weight in the index The Nifty comprises of 50 stocks. BSE Sensex comprises of 30 stocks. For example, Nifty was formed in 1995 and given a base value of 1000. The value of Nifty today is 1172. What it means in simple terms is that, if Rs 1000was invested in the stocks that form in the index, in the same proportion in which they are weighted in the index, then Rs 1000 would have become Rs 1172 today. What the terminologies used in a Futures contract? The terminologies used in a futures contract are: • Spot Price: The current market price of the scrip/index • Future Price: The price at which the futures contract trades in the futures market • Tenure: The period for which the future is traded • Expiry date: The date on which the futures contract will be settlec • Basis : The difference between the spot price and the future price Why are index futures more popular than stock futures? Globally, it has been observed that index futures are more popular as compared to stock futures. This is because the index future is a relatively low risk product compared to a stock future. It is easier to manipulate prices for individual stocks but very difficult to manipulate the whole index. Besides, the index is less volatile as compared to individual stocks and can be better predicted than individual stock