NISM-Series-VIII: Equity Derivatives · Basics of Derivatives

Participants in Derivatives Markets: Hedgers, Speculators and Arbitrageurs

Updated 11 October 2026 · Fact-checked

Derivatives markets have three main participants. Hedgers use derivatives to reduce an existing price risk. Speculators take on risk to profit from price moves. Arbitrageurs lock in risk-free profit from price gaps between markets. Identify the participant by the motive: protect, bet, or exploit a mispricing.

Understand Participants in Derivatives Markets

A derivative is a contract whose value comes from an underlying asset such as a stock, an index or a commodity. Many different people trade these contracts. NISM groups them by motive, not by who they are. The same firm can act as a hedger in one trade and a speculator in another.

Hedgers already have a risk from the underlying market. A person holding shares fears a fall in price. A company expecting to buy a commodity fears a rise in price. The hedger takes a derivative position that offsets that risk. The aim is protection, not profit. Hedging does not remove risk for free. It gives up some possible gain, and it costs margin or premium.

Speculators have no underlying exposure to protect. They take a view on the direction or volatility of prices and take a position to profit from it. They accept risk willingly. Because derivatives need only margin (futures) or a premium (options) rather than the full value, a speculator gets leverage. Leverage magnifies both gains and losses. Speculators are important because they supply liquidity. Hedgers need someone willing to take the other side of their risk.

Arbitrageurs look for the same asset, or equivalent assets, priced differently in two markets. They buy where it is cheap and sell where it is dear, at the same time. Done correctly, the profit is locked in with little or no risk. A common case is the gap between the spot price and the futures price. Their trading pushes prices back in line, so they keep the cash and derivatives markets consistent with each other.

Some books also mention margin traders and market makers, but the three groups above are the core of this topic. A quick test for any question: does the person have a risk to remove (hedger), a view to bet on (speculator), or a price gap to lock in (arbitrageur)?

Key formulas to remember

Hedger: Existing exposure in spot + opposite position in derivative → lower price risk; Motive is risk reduction. Not profit-seeking from direction.
Speculator: No underlying exposure + directional view → derivative position; Takes risk, uses leverage, provides liquidity.
Arbitrageur: Buy in cheaper market + sell in dearer market at the same time → locked-in profit; Aims at risk-free profit from mispricing. Keeps markets aligned.
Cash and carry (basic idea): Futures price above fair value → buy spot, sell futures; Reverse cash and carry is the opposite: sell spot, buy futures when futures are too cheap.

How to solve Participants in Derivatives Markets questions

Use this method for any question that asks you to name or describe a market participant.

1Read the scenario and find the person's starting position. Do they hold the underlying or expect to buy or sell it?
2Find the motive word: protect, safeguard, offset (hedger); expect, view, bet, anticipate (speculator); price difference, simultaneous, risk-free (arbitrageur).
3Check the derivative position against the spot position. If it offsets the spot risk, it is hedging.
4If there is no underlying exposure and the person is taking a view, it is speculation.
5If the person trades two markets at once to capture a price gap, it is arbitrage.
6Check the options for trap words such as 'eliminates all risk' or 'only speculators provide liquidity' and reject overstated claims.
7Pick the option that matches the motive, not the instrument used.

Quickest way: Motive test: protect, bet, or lock

When to use it: Use for any one-line MCQ that describes what a trader is doing.

Ask: does the trader already have a risk? If yes, hedger.
If no risk but a market view, speculator.
If two simultaneous trades in related markets for a price gap, arbitrageur.
Ignore the instrument. Futures and options can be used by all three.

Common mistakes in Participants in Derivatives Markets

Deciding the participant from the instrument, such as 'options users are speculators'.
Students link futures and options with trading for profit.
Fix: Judge by motive and existing exposure. Any of the three can use any derivative.
Saying a hedger earns profit from the hedge.
Students focus on the derivative leg alone.
Fix: Look at the whole position. The derivative gain or loss offsets the spot move. The aim is stability.
Treating speculators as harmful and unnecessary.
Everyday use of the word 'speculation' is negative.
Fix: Remember that speculators take the risk hedgers want to shift and add liquidity to the market.
Thinking arbitrage involves taking a view on price direction.
Students confuse it with speculation.
Fix: Arbitrage uses simultaneous opposite positions so direction does not matter. Profit comes from the price gap.
Believing hedging removes all risk at no cost.
Textbook definitions say 'offset risk' loosely.
Fix: Hedging reduces risk. It costs margin or premium, and it may limit gains. Basis risk can remain.
Assuming arbitrage is always entirely risk-free in practice.
The definition says 'risk-free'.
Fix: It is risk-free in theory when trades are done together. Costs and execution gaps can reduce or remove the profit.

Worked examples

Example 1

An investor holds shares of a company worth ₹10,00,000 and fears a short-term fall in the market. She sells index futures to protect the value. Which participant is she, and why?

Show the solution

She already holds shares, so she has an existing price risk.
Her risk is a fall in price. Selling futures gains if prices fall.
The futures position offsets the loss on her shares.
Her motive is protection, not profit from a view.

Answer: She is a hedger, because the derivative position is taken to offset an existing spot exposure.

Example 2

A trader notices that a stock is available at ₹500 in the cash market, while its one-month futures trade at ₹530. The cost of carry to the expiry is ₹10. What does an arbitrageur do, and what is the locked-in gain per share before other costs?

Show the solution

The fair futures price is spot plus carry cost: ₹500 + ₹10 = ₹510.
Futures at ₹530 are higher than ₹510, so futures are overpriced.
Buy the stock in the cash market at ₹500 and sell the futures at ₹530 at the same time.
Hold to expiry. Futures converge to spot, so the position closes with the price gap realised.
Gain per share = ₹530 − ₹510 = ₹20.

Answer: The arbitrageur buys spot and sells futures (cash and carry). The gain is ₹20 per share before brokerage and other charges.

Exam tips

Questions usually give a short scenario. Name the participant by motive and ignore the instrument.
Watch absolute words such as 'always', 'eliminates' and 'no risk' in hedging and arbitrage options. They are often traps.
Remember that speculators supply liquidity and that arbitrageurs keep spot and futures prices aligned.
Negative marking is 25% of the marks for the question in NISM-Series-VIII, so skip only if you are truly unsure between two options.

Practice questions from Basics of Derivatives

Participants in Derivatives Markets in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Participants in Derivatives Markets: frequently asked questions

What is the difference between hedgers, speculators and arbitrageurs?

A hedger has an existing risk and uses derivatives to reduce it. A speculator has no such risk and bets on price moves for profit. An arbitrageur trades related markets at the same time to capture a price gap with little or no risk.

How do arbitrageurs use derivatives?

They compare the futures price with the spot price plus cost of carry. If futures are too high, they buy spot and sell futures. If futures are too low, they do the reverse. This locks in the gap and pulls prices back into line.

Why do derivatives markets need speculators?

Hedgers want to pass on their risk. Speculators are willing to take it and also add trading volume. This makes it easier for everyone to enter and exit positions.

Can one person be both a hedger and a speculator?

Yes. The label depends on the purpose of each trade. An investor can hedge one holding with futures and speculate with a separate position in another contract.