Equity Derivatives

Equity Derivatives Latest News

SEBI has come out with a new framework for monitoring intraday positions in equity index derivatives, a move aimed at preventing risks caused by large exposures.

What are Derivatives?

• Derivatives are financial contracts that derive value from an underlying asset. 
• Derivatives allow traders to bid on the direction of the underlying asset’s price change without owning them. 
• They allow investors to speculate on price movements, hedge against risks, or enhance portfolio returns.

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About Equity Derivatives

• Equity derivatives are financial instruments whose value is derived from the movements of a stock or a stock index. 
• Equity derivatives serve various purposes for investors and traders, including risk management, speculation, and portfolio optimisation.

Equity Derivative Types

• Futures Contracts: These obligate the buyer to purchase and the seller to sell an underlying equity asset at a predetermined price and future date.  Equity index futures, like the BSE S&P and Nifty IT, are popular examples.
• Options: Equity options give the holder the right, but not the obligation, to buy (call option) or sell (put option) an underlying stock or index at a specified price before or on a specific expiration date.
• Swaps: Equity swaps involve exchanging cash flows based on the return of an underlying equity asset. These can be used for hedging or investment purposes.
• Forwards: Forwards are the same as futures, where the parties are obligated to perform the contract. But forwards are non-standardised, over-the-counter contracts that don’t trade on the stock exchanges.

Advantages of Equity Derivatives

• Leverage: Equity derivatives typically require a smaller upfront investment compared to buying the underlying assets directly.This  allow investors to control a larger position in the underlying asset with a smaller investment, magnifying potential gains (but also losses).
• Hedging against price volatility: They provide a means to protect against adverse price movements in the stock market, reducing the risk of financial losses.
• Access to premium assets: By investing in these derivatives, investors can gain exposure to high-value, unaffordable or inaccessible assets.
• Cost efficiency: Trading equity derivatives typically requires lower transaction costs than directly investing in the underlying assets, making it a cost-effective choice.
• Arbitrage opportunities: They can be utilised to exploit price discrepancies between different markets, enabling investors to profit from market inefficiencies.
• Portfolio diversification: Including these derivatives in an investment portfolio can diversify risk by adding different asset classes and strategies.
• Flexibility: They offer various strategies and contract types, allowing investors to adapt their positions based on market conditions and investment objectives.
• Liquidity: The derivatives market tends to have high liquidity, ensuring ease of buying and selling positions without significant market impact.
• Risk management: They provide tools for managing risk exposure, allowing investors to mitigate losses and protect their portfolios.
• Income generation: Through option writing or other derivative strategies, investors can generate income from their equity positions, enhancing overall returns.

Source: TH