Why in the news?

  • SEBI issued new rules for monitoring intraday positions in equity derivatives.

Equity Derivatives

  • What is it?:
    • Derivative: A financial instrument whose value is derived from an underlying asset (e.g., equity shares, commodities, currencies, indices).
    • Equity Derivatives: An equity derivative is a financial instrument whose value is derived from the price movements of an underlying equity asset, such as a stock.
      • Traders use equity derivatives to speculate and manage risk.
  • Types:
    • Forwards: OTC contracts, customized, high default risk.
    • Futures: Exchange-traded, standardized, lower counterparty risk.
      • Example: NIFTY Futures, Stock Futures.
    • Options: Gives right but not obligation to buy/sell.
      • Call Option: Right to buy.
      • Put Option: Right to sell.
      • Example: NIFTY Call Option (strike price ₹20,000).
    • Swaps: Exchange of cash flows linked to equity returns. Rare in India for equity.
  • Purpose of Equity Derivatives:
    • Hedging: Protects investors from adverse price movements.
    • Speculation: Traders take positions for profit from expected price changes.
    • Arbitrage: Exploiting price differences between cash and derivative markets.
    • Portfolio Management: Diversification and risk management using index derivatives.
  • Regulatory Framework in India:
    • Regulated by SEBI (Securities and Exchange Board of India).
    • Derivative trading was introduced in India in 2000 (NSE launched index futures first).
    • Derivatives allowed only in dematerialised & exchange-traded form (not OTC for retail).
    • Trading occurs mainly on NSE and BSE.
  • Concerns:
    • High Volatility: Can magnify gains and losses.
    • Leverage Risk: Small investment controls large value → high exposure.
    • Counterparty Risk: Minimal on exchanges but exists in OTC.
    • Speculative Bubble: Over-speculation may destabilize equity markets.