NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to the Indian Financial Markets

Derivatives Market Overview for NISM Investment Adviser

Updated 11 October 2026 · Fact-checked

A derivative is a contract whose value depends on an underlying asset such as a share, index, currency or commodity. Futures, options, forwards and swaps are the main types. You use them to hedge risk, speculate or arbitrage. In India, futures and options trade on exchanges; forwards and swaps are mostly over the counter.

Understand Derivatives Market Overview

A derivative is a financial contract. It has no value of its own. Its value comes from an underlying, such as a stock, an index like Nifty 50, a currency pair, a commodity or an interest rate.

There are four basic types. A forward is a private agreement to buy or sell an asset at a fixed price on a future date. A future is the same idea, but standardised and traded on an exchange. An option gives the buyer a right, not an obligation, to buy or sell at a fixed price. A swap is an agreement to exchange cash flows over a period, for example fixed-rate interest for floating-rate interest.

People use derivatives for three purposes. Hedging reduces an existing risk. Speculation takes a view on price direction to earn profit, accepting risk. Arbitrage earns a low-risk profit from a price gap between two markets. Remember that hedging is about cutting risk, not about making extra profit.

Markets are of two kinds. Exchange-traded contracts are standardised in lot size and expiry. They are cleared by a clearing corporation, which guarantees settlement and so removes most counterparty risk. Over-the-counter (OTC) contracts are customised between two parties and carry counterparty risk, which is the chance the other side defaults.

In India, equity futures and options trade on exchanges such as NSE and BSE, and SEBI regulates them. Index and stock derivatives are the most traded. Forwards and swaps are mainly OTC, largely in currency and interest rates, where the RBI is the regulator.

Key formulas to remember

Long futures profit: Profit = (Settlement price − Entry price) × Lot size; The buyer gains when price rises. The seller (short) has the opposite result: (Entry price − Settlement price) × Lot size.
Call option buyer payoff at expiry: Payoff = Max(Spot − Strike, 0) − Premium; Maximum loss is the premium paid. Profit is unlimited in theory.
Put option buyer payoff at expiry: Payoff = Max(Strike − Spot, 0) − Premium; Maximum loss is the premium paid. Profit is limited because the price cannot fall below zero.
Option seller (writer) position: Writer's profit = Premium received − Buyer's payoff before premium; The writer's gain is capped at the premium. Loss can be large, and for a call it is unlimited in theory.
Hedge ratio by number of lots: Lots = Value of holding ÷ (Futures price × Lot size); Gives the approximate number of lots to sell to hedge a stock portfolio with a one-to-one hedge. Round to a whole number.

How to solve Derivatives Market Overview questions

Use this method for definition, comparison, hedging and payoff questions.

1Identify the instrument: forward, future, option or swap. Note whether it is exchange-traded or OTC.
2Identify the purpose in the question: hedging, speculation or arbitrage.
3Fix the position: long or short, buyer or seller, call or put.
4Recall who holds the right and who holds the obligation. Only the option buyer has a right.
5For numbers, use the right payoff formula and multiply by the lot size.
6For options, include the premium. Buyer pays it, seller receives it.
7Check the answer against the limits: option buyer loss is capped at the premium, option writer gain is capped at the premium.
8Eliminate options that mix up terms such as hedging with speculation or forward with future.

Quickest way: Four-question shortcut

When to use it: Use it for any conceptual MCQ when time is short.

Ask: standardised and exchange-traded? Then it is a future or an exchange option. Customised and private? Then forward or swap.
Ask: does one side have only a right? Then it is an option and that side is the buyer.
Ask: is the aim to reduce risk? Then it is hedging.
Ask: who can lose a lot? Futures parties and option sellers. Option buyer loses only the premium.

Common mistakes in Derivatives Market Overview

Saying an option buyer is obliged to trade at expiry.
Futures and options are studied together, so the features blur.
Fix: Buyer has the right, seller has the obligation. Futures bind both sides.
Treating forwards as exchange-traded.
Forwards and futures sound alike.
Fix: Forwards are OTC and customised with counterparty risk. Futures are standardised and cleared by a clearing corporation.
Forgetting the premium in option profit.
Students compute only Spot − Strike.
Fix: Always subtract the premium for the buyer. Then check the sign.
Forgetting the lot size.
Questions give a per-unit price movement and students stop there.
Fix: Multiply the per-unit result by the lot size given in the question.
Calling a hedge a profit-making trade.
Derivatives are linked with trading gains.
Fix: A hedge reduces risk and may give up some gain. A speculator accepts risk for profit.
Saying the put buyer profits when price rises.
Direction gets reversed under time pressure.
Fix: A put buyer gains when the price falls. A call buyer gains when it rises.

Worked examples

Example 1

An investor buys one Nifty futures contract at 22,000 with a lot size of 75. At expiry, the settlement price is 22,120. What is the profit or loss?

Show the solution

The investor is long, so profit = (Settlement − Entry) × Lot size.
Settlement − Entry = 22,120 − 22,000 = 120 points.
Profit = 120 × 75 = ₹9,000.

Answer: Profit of ₹9,000

Example 2

An investor buys a call option on a stock with strike ₹500 and pays a premium of ₹20 per share. The lot size is 100. At expiry the stock is at ₹540. What is the net profit?

Show the solution

The call is in the money: Spot − Strike = 540 − 500 = ₹40 per share.
Subtract the premium: 40 − 20 = ₹20 per share.
Multiply by lot size: 20 × 100 = ₹2,000.

Answer: Net profit of ₹2,000

Exam tips

Expect definition questions asking which instrument gives a right without an obligation. The answer is the option buyer.
Learn the standard contrasts: exchange-traded versus OTC, standardised versus customised, and clearing corporation guarantee versus counterparty risk.
In payoff questions, check lot size and premium before choosing an answer.
Read the purpose carefully. Hedging, speculation and arbitrage each have a distinct meaning.
On X-A, wrong answers cost 25% of the question's marks, so skip a question only if you are truly unsure.

Practice questions from Introduction to the Indian Financial Markets

Derivatives Market Overview in other exams

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

Derivatives Market Overview: frequently asked questions

What is the difference between futures and options?

A futures contract binds both buyer and seller to trade at the agreed price on expiry. An option gives the buyer a right but no obligation, in return for a premium. The option seller is obliged to trade if the buyer exercises.

How do you hedge using derivatives?

You take a derivative position that moves opposite to your existing exposure. For example, someone holding shares can sell index or stock futures, or buy put options, so a fall in share prices is offset by a gain on the derivative.

Are forwards and swaps traded on exchanges in India?

They are mainly over-the-counter contracts, customised between two parties. Exchange-traded derivatives in India are mainly futures and options, which are standardised and cleared through a clearing corporation.

Why does the clearing corporation matter?

It stands between buyer and seller and guarantees settlement of exchange-traded trades. This removes most counterparty risk, which is a key difference from OTC contracts.