Derivatives

Derivatives trading takes place under the Securities and Exchange Board of India Act, 1992 and the framework including suggestive bye-law and its Clearing Corporation/House has been laid down by Dr. L.C. Gupta Committee, constituted by SEBI.
Some of the eligibility conditions laid down by SEBI for Derivative Exchange/Segment and its Clearing Corporation/House are as follows:
The Derivatives Exchange/Segment shall have on-line surveillance capability to monitor positions, prices, and volumes on a real time basis so as to deter market manipulation. The Derivatives Exchange/ Segment should have arrangements for dissemination of information about trades, quantities and quotes on a real time basis through atleast two information vending networks, which are easily accessible to investors across the country. The Derivatives Exchange/Segment should have arbitration and investor grievances redressal mechanism operative from all the four areas / regions of the country. The Derivatives Exchange/Segment should have satisfactory system of monitoring investor complaints and preventing irregularities in trading. The Derivative Segment of the Exchange would have a separate Investor Protection Fund. The Clearing Corporation/House shall perform full novation, i.e., the Clearing Corporation/House shall interpose itself between both legs of every trade, becoming the legal counterparty to both or alternatively should provide an unconditional guarantee for settlement of all trades. The Clearing Corporation/House shall have the capacity to monitor the overall position of Members across both derivatives market and the underlying securities market for those Members who are participating in both. The level of initial margin on Index Futures Contracts shall be related to the risk of loss on the position. The concept of value-at-risk shall be used in calculating required level of initial margins. The initial margins should be large enough to cover the one-day loss that can be encountered on the position on 99% of the days. The Clearing Corporation/House shall establish facilities for electronic funds transfer (EFT) for swift movement of margin payments. In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House shall transfer client positions and assets to another solvent Member or close-out all open positions. The Clearing Corporation/House should have capabilities to segregate initial margins deposited by Clearing Members for trades on their own account and on account of his client. The Clearing Corporation/House shall hold the clients' margin money in trust for the client purposes only and should not allow its diversion for any other purpose. The Clearing Corporation/House shall have a separate Trade Guarantee Fund for the trades executed on Derivative Exchange / Segment. Presently, SEBI has permitted Derivative Trading on the Derivative Segment of BSE and the F&O Segment of NSE.
The rights of investors in the Derivative Market are well protected by SEBI. The measures specified by SEBI are as follows:
Investor's money has to be kept separate at all levels and is permitted to be used only against the liability of the Investor and is not available to the trading member or clearing member or even any other investor. The Trading Member is required to provide every investor with a risk disclosure document which will disclose the risks associated with the derivatives trading so that investors can take a conscious decision to trade in derivatives. Investor would get the contract note duly time stamped for receipt of the order and execution of the order. The order will be executed with the identity of the client and without client ID order will not be accepted by the system. The investor could also demand the trade confirmation slip with his ID in support of the contract note. This will protect him from the risk of price favour, if any, extended by the Member. In the derivative markets all money paid by the Investor towards margins on all open positions is kept in trust with the Clearing House/ Clearing corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilised towards the default of the member. However, in the event of a default of a member, losses suffered by the Investor, if any, on settled / closed out position are compensated from the Investor Protection Fund, as per the rules, bye-laws and regulations of the derivative segment of the exchanges
FAQs on Derivatives
What is the lot size of a contract?Lot size refers to number of underlying securities in one contract. Addition to it, for stock specific derivative contracts SEBI has specified that the lot size of the underlying individual security should be in multiples of 100 and fractions, if any, should be rounded of to the next higher multiple of 100. This requirement of SEBI along with the requirement of minimum contract size makes the basis of arriving at the lot size of a contract.
Is there any market wide limits?For index products it is nil.For stock specific products it is of open positions.For an option and futures it is as undementioned: 30 times the average number of shares traded daily, during the previous calendar month, in the cash segment of the Exchange, OR 10% of the number of shares held by non-promoters i.e. 10% of the free float, in terms of number of shares of a company. It is also specified that when the total open interest in a contract reaches 80% of the market wide limit in that contract, the exchanges would make the price scan range and volatility scan range (specified) double. The exchanges has to continuously review the impact of measures and take further proactive risk containment measures as may be appropriate, including, further increases in the scan ranges and levying additional margins.
Derivatives
What are derivatives? Derivative as the name suggests are the financial contracts which derive their value from the underlying. The underlying may be the security or an index. Thus derivative instruments have no independent value. Rather their values are dependent on the price of the underlying instruments which they represent.
What are forward contracts? Forward Contracts are contracts where two parties agree to do a trade at a future date at the pre determined or agreed price and quantity. Thus the trade takes place at a future date but the terms of the trade are determined previously.
What are the problems of forward contracts?Forward Contracts are between two parties, Hence these are individual contracts which are settled between the two parties to the contracts. However these are not traded on the stock exchange. Hence they are illiquid. They also suffer from the counterparty risk as in case of default by one party, there is no settlement guarantee as they are not traded on the exchange.
What are future contracts? Future Contracts have come into existence to tide over the problems of the forward contracts. Future contracts are standardized contracts with standard conditions and terms. They are traded on the stock exchange and settlement of the contracts takes place through the clearing corporation of the stock exchange, which assumes the counterparty risk. This it acts as a buyer to the seller and a seller to the buyer and in case of default of any of the parties, the settlement is guaranteed by the clearing corporation.
What is an Index future Contract?An Index future contract is where the underlying security is not an individual share but the Index such as Sensex, Nifty, IT Index, Bank Index and so on. These contracts derive their value from the value of the underlying index