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INDEX DERIVATIVES

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Index Derivatives

Index derivative is the financial derivative contract that has an underlying asset as the index itself.
Index derivatives allow an investor to trade in a group of assets the index represents, without having to buy each underlying security/ asset in that group or market.
Index derivatives include options and futures contracts.
Examples of the index derivatives along with their underlying asset (index) are

Nifty futures and Nifty options:- for both the futures and options the underlying asset is Nifty 50
Bank Nifty futures and Bank nifty options: – Bank Nifty is the underlying asset

Index Futures :

Index futures are a type of futures contract that allows traders to bet on the future direction of a stock index. Thus, these allow investors to speculate on the future direction of an underlying stock market index. By trading index futures in India, investors can gain exposure to the broader market and potentially profit from anticipated market movements.

Index futures operate like standard futures contracts but with a stock index as the underlying asset. Index futures are similar to other futures contracts in that they have a predetermined price, an expiration date, and a margin requirement. They involve an agreement to pay a specific price on a set expiration date. These contracts are cash-settled due to the nature of index assets, with daily settlements on a mark-to-market basis.

Benefits:

  • Index futures are highly liquid, meaning that there are always buyers and sellers in the market. This makes it easy to enter and exit positions, and to get a good price for your contracts.
  • Index futures can be used to hedge against risk. For example, a portfolio manager who owns a large number of stocks might buy share index futures to protect their portfolio against a decline in the stock market.
  • Stock market Index futures can also be used for speculation. For example, a trader who believes that the stock market is going to go up might buy index futures in the hopes of making a profit.
  • The margin requirements for share index futures are typically lower than the margin requirements for other types of futures contracts. This makes them more accessible to smaller investors.

Index Options:

  • The basic idea of index options is that an options contract is traded with an underlying asset being an index, instead of a set of particular stocks of one company.An index option is an options contract giving the holder of the contract the right to buy or sell an underlying asset which is an index at a predetermined price at a stipulated date of expiry. The value of the index reflects the value of the options contract. Again, like any other underlying asset in options contracts, the holder is under no obligation to exercise the contract by the date of expiry.
  • Index options, in most cases, are offered when futures are already in the markets. This offers a benchmark that reflects option pricing. Once the strike prices, lot sizes and numerous dates of expiry are fixed and defined, index options are made available for trading.

Benefits:

  • Index options offer significant leverage, allowing traders to control a substantial amount of notional value with a relatively small investment.
  • Index options trading offers both bullish and bearish strategies, enabling traders to profit from both rising and falling markets.
  • Index options can be employed as hedging instruments to protect against potential losses in underlying stock portfolios.