NISM Series VIII, Chapter 1. Updated Jun 2026, 8-minute read.

Introduction to Derivative Markets

Derivative markets allow participants to manage risk, speculate on price movements, and improve market efficiency. Chapter 1 of NISM Series VIII covers the foundational concepts you need to understand before diving into futures and options.

Key takeaways

Derivatives derive their value from an underlying asset — equity, index, commodity, currency, or interest rate
Four main types: Forwards, Futures, Options, and Swaps
India's derivatives market is regulated by SEBI; NSE's F&O segment is the primary exchange
Key participants: Hedgers (risk transfer), Speculators (liquidity), Arbitrageurs (price efficiency)
SEBI permitted equity derivatives trading in India in June 2000 starting with Nifty 50 index futures
Derivatives serve both economic functions (price discovery, risk transfer) and sometimes speculative ones

What is a Derivative?

A derivative is a financial contract whose value is derived from the performance of an underlying entity — which could be an equity share, stock index, commodity, currency pair, or interest rate.

The underlying asset does not change hands in most derivative transactions. Instead, the parties settle based on the price change of the underlying.

Types of Derivatives

1. Forwards

A forward is an OTC (over-the-counter) agreement between two parties to buy/sell an asset at a future date at a price agreed today. Forwards are customised but carry counterparty risk — the risk that the other party defaults.

2. Futures

Futures are standardised forwards traded on an exchange. Counterparty risk is eliminated because the exchange clearing corporation (NSCCL for NSE) guarantees settlement. All equity futures in India are cash-settled.

3. Options

Options give the buyer a right but not an obligation to buy or sell. The buyer pays a premium; the seller earns the premium but takes on the obligation. NSE lists both index options (Nifty, Sensex) and single-stock options.

4. Swaps

Swaps are OTC agreements to exchange cash flows (e.g., fixed for floating interest rates). Common in currency and interest rate risk management. Not exchange-traded in India.

Market Participants

Hedgers: Use derivatives to reduce existing exposure. E.g., a fund manager holding a Nifty portfolio buys Nifty put options to protect against a market fall.
Speculators: Take calculated risk positions hoping to profit from price movements. They provide liquidity to the market.
Arbitrageurs: Exploit price differences between the spot and futures markets (or between two exchanges) for riskless profit, helping bring prices into alignment.

History of Derivatives in India

June 2000: SEBI permitted index futures on Nifty 50 and Sensex
June 2001: Index options introduced
July 2001: Stock options introduced
November 2001: Stock futures introduced
2008 onwards: Currency derivatives, interest rate derivatives added
2014 onwards: Weekly options introduced

Economic Functions of Derivatives

Price Discovery: Futures prices reflect market consensus on future spot prices, providing valuable forward-looking information.
Risk Transfer: Hedgers transfer price risk to speculators who are willing to bear it for a profit opportunity.
Market Completeness: Allow strategies (e.g., going short, leveraged exposure) that are difficult or impossible in spot markets.

Frequently asked questions

What is the underlying asset for Nifty 50 futures?

The underlying for Nifty 50 futures and options is the NSE Nifty 50 Index, which tracks the 50 largest and most liquid Indian stocks across 13 sectors.

Why are futures prices higher than spot prices?

In a normal market (contango), futures prices are higher than spot because they include the cost of carry — the interest cost of holding the underlying position until expiry. If dividends are expected, they reduce the futures premium.

Who introduced derivatives regulation in India?

SEBI is the primary regulator. The L.C. Gupta Committee (1997) and J.R. Varma Committee (1998) laid the groundwork for India's equity derivatives framework. NSE launched the first exchange-traded derivatives in June 2000.

Written by Arpan Das.

Keep going with Series VIII