Derivatives, described
What is a futures contract, what is an option, and where does the risk sit?
12 of 12 chapters published
Chapters
Beginner
- What a derivative isA contract whose value comes from something else. That one sentence explains the whole category — and the fact that the contract is an agreement between two people explains why someone always loses what someone else gains.
- FuturesAn agreement to trade something at a fixed price on a fixed date, binding on both sides. No money changes hands for the thing itself — only margin — which is what makes a small deposit control a large position.
- OptionsA right for the buyer and an obligation for the seller. The buyer pays a premium and can lose only that; the seller receives it and can lose far more. Everything difficult about options comes from that asymmetry.
- The contract specificationLot size, strike, expiry and settlement are set by the exchange, not by you. SEBI raised contract sizes and cut the number of weekly expiries in 2024 and 2025, and both changes were aimed squarely at retail participation.
Intermediate
- Margin and leverageMargin is a deposit, not a price, so a fraction of the money controls the whole position. That multiplies the move in both directions — and because losses are collected daily, it can end a position that would have been right.
- PayoffsFour lines on a chart settle most arguments about options. The buyer's loss is flat and their gain slopes; the seller's gain is flat and their loss slopes. Everything else is a combination of those four shapes.
- What an option price is made ofTwo parts: what it would be worth exercised now, and what you are paying for the time left. The second part drains away every day, fastest at the end, and it is why most bought options expire at nothing.
- Hedging and speculatingThe same contract does both, and the difference is whether you already carry the risk you are trading. A hedge reduces an exposure you have; a speculation creates one you did not.
Advanced
- Selling options and tail riskCollecting premium wins most months by design, which is what makes it dangerous. A strategy that is right eighty-five per cent of the time can still lose money overall, and the losing fifteen per cent arrives all at once.
- What happens to individual tradersSEBI has measured it four years running. Around nine in ten individual traders lose money in equity derivatives, the aggregate loss reached ₹1,05,603 crore in FY25, and the average loss per person was ₹1,10,069.
- CostsBrokerage, exchange fees, stamp duty, securities transaction tax and the spread, charged on a notional value far larger than your deposit. On small premiums they are a large fraction of the trade before it starts.
- When derivatives make senseWhen you hold a risk you want to reduce, and the cost of reducing it is worth paying. That is a short list, and for almost everyone reading this the right use of the subject is to understand the instruments and not to trade them.