When derivatives make sense

Eleven chapters of mechanism and evidence. This one is what to do with it.

The narrow list

Four situations where a derivative genuinely serves an individual.

A concentrated holding you cannot sell. Employee shares under lock-in, an inherited stake, a position whose sale would trigger a tax event you want to defer. A protective put sets a floor for the cost of the premium. Real exposure, sized hedge, known cost.

A business exposure, not an investment one. An exporter owed dollars, an importer owing them. The hedge lets the business be paid for its business.

A known liability against a portfolio. Money committed in three months against shares you intend to keep. A short index future bridges the gap without selling.

Professional risk management, if that is your job.

The common feature is chapter 8's test: you already carry the risk. Remove that and nothing on the list applies.

The questions, if you are going to anyway

People will trade derivatives after reading this, and a page of warnings they skip is less useful than questions they can answer.

1. What risk do I already hold that this reduces? If the answer is none, this is a bet. That is allowed, and it should be called by its name.
2. What is my maximum loss, in rupees, on this position? For a bought option, the premium. For a sold option or a future, work it out before trading, not after.
3. Can I fund every margin call between now and expiry? Chapter 5: being right at expiry is worth nothing if you are closed out in week two.
4. What does this cost round trip, as a share of the premium? Chapter 11, from an actual contract note.
5. What has to happen, by when? Chapter 7: direction, distance and timing, all three.
6. What percentage of my net worth is at risk here? Including the open-ended part if you have sold.
7. What specifically do I have that the 91% did not? Chapter 10. If there is no answer, that is the answer.

Anyone who can answer all seven is in a different position from most participants. The purpose of the list is that most people cannot answer three of them, and finding that out costs nothing.

Rules worth keeping if you do

Never sell naked options with money you need. Chapter 9: the loss is open-ended, the gap prevents exit, and rising margin forces it.

Size by the worst case, not the expected one. Then halve it.

Avoid expiry day. Chapter 7: the percentage swings are real and they are percentages of a number designed to be small.

Keep a record. Every trade, the reason, the outcome. After fifty trades you have your own data instead of an impression, and your own data is the only thing that can tell you whether you are in the 9%.

Add up your costs monthly and compare them with your net result.

And what to do instead

The uncomfortable part, and the honest one.

For almost everyone, the money and the attention that go into derivatives would compound better in the earlier subjects of this course: a sensible savings rate, an index fund held through a fall, an understanding of the business behind a share.

Those are slower, duller, and they do not produce a story. They also do not have a 91% loss rate attached to four consecutive years of regulatory data.

Why the subject exists at all

Not to discourage you — to make you literate.

Derivatives set prices in the markets you participate in. Options volume affects the indices your fund tracks. The instruments appear in scheme documents, in company accounts as hedges, and in every financial conversation. Understanding them is part of understanding the market.

And the strongest argument against trading them is the one this subject spent eleven chapters building, rather than an assertion on the first page. You now know what a derivative is, why the segment is negative sum, how leverage kills positions that were right, why bought options decay and sold options have tails, and what SEBI measured across ninety-six lakh people.

That is enough to decide for yourself, which was the point.

The point

Derivatives make sense when you already hold a risk you want to reduce and the cost of reducing it is worth paying. Outside that list, the seven questions are the test — and for almost everyone the right use of this subject is to understand the instruments, not to trade them.