FAQs, Frequently Asked Questions of Trading, investments on Indian stock market in India

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Frequently asked Questions

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1. What do you mean by derivatives?
2. Why do people trade in derivatives and who are those people?
3. When did derivative trading start on Indian stock market?
4. Can I buy a six months ahead / future contract or an option?
5. What is the lot size for various contract?
6. What do you suggest me, Whether I should go for future trading or option trading and what is the difference?
7. What is the difference between American options and European options in the India context?
8. What is the difference between In the money option, At the money option and Out of the money option?

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1. What do you mean by derivatives?

Ans- Derivatives is a product which gives its value from another underlying asset which can be equity stock, commodity or any other asset. Here on the Indian stock market, it is the stock in question which is the asset and the future of it is a derivative. The option is also derived from the underlying stock.

2. Why do people trade in derivatives and who are these people?

Ans- It is the hedgers, speculators and arbitrageurs who are the most active in the derivative market. The hedgers try to eliminate the risk, speculator try to play on the price movement whereas arbitrageurs play the leverage game difference between the spot and the future market. At the of the month the future and the underlying stock price try to become the same and this is where the arbitrageurs make a killing without risk.

3. When did derivative trading start in Indian stock market?

Ans- Derivative trading started in India in June 2000 and now volumes in derivative market have overtaken the cash market. Rather it has been seen that index futures contract on S and P CNX Nifty and BSE 30 (Sensex) are very popular as the small investor can also hatch his position easily. The trading in index option started in June 2001 and trading in option on individual stock started in July 2001.

4. Can I buy a six months ahead / future contract or an option?

Ans- On Indian stock market one can buy a maximum of 3 months contract. You can have a one month, two months and three months futures and not more than that. On the last Thursday of the month, the contract expires and a new contract starts from the next working day. If the last Thursday is a holiday then the previous working day is treated as the last day.

5. What is the lot size for various contract?

Ans- The lot sizes for various contract varies and at the moment they are as per the NSE as on 6th february, 2005 . Lot sizes
for latest updating go to www.nseindia.com

6. What do you suggest me, Whether I should go for future trading or option trading and what is the difference?

Ans- Future trading in the Indian stock market refers to the buying and selling of the stock futures of individual stock. If you have to buy one future of nifty (one future of nifty equals 200 nifty), you need to pay a margin between 25-50% depending upon the volatility of the index. For example, if you wish to buy future of Satyam Computers, then you need to buy 1200 Satyam's, which is one lot size of Satyam future. Any price movement (up or down) you either get profit or loss. The profits and losses are unlimited while buying or selling a future. When we buy an option i.e., a call or a put we only need to pay the premium and that is the only risk we have. Options can be on the index as well as the stocks. Stock options are option on individual index. The buyer of an option pays the premium to the seller of the option. The buyer of an option is under no obligation to exercise his option but the seller of the option has to fulfill his obligation if the buyer demands For example, If you buy an index call option at a premium of Rs.20, then at the end of the month the maximum loss you can have is Rs.20, but the profit is unlimited where as the seller of the option will have maximum profit of Rs.20 only and his loss is unlimited. The seller of an option is also called an option writer. New investors and traders should not indulge in option writing or selling. An investor can buy a put option if he thinks that the market is going to go down. He has to pay only premium to the writer. The investors buys the put option which gives the investor the right but not the obligation to sell the stock at a later stage. The date specified at which the option has to mature is called the expiration date i.e., the last Thursday of the month. The price specified in the option contract is called the strike price. So a new investor is advised to buy call or put options rather than selling options or trading in future.

7. What is the difference between American options and European options in the India context?

Ans-The index options are mainly European in style as they can be exercised only on the expiration date. Whereas American options can be exercised at any date before the expiry of an option. Indian stock options are American style.

8. What is the difference between In the money option, At the money option and Out of the money option?

Ans- An In the money option is one where the call option has the spot price is greater than the strike price (Spot Price > Strike Price).

At the money option is one where the call option has the spot price equals the strike price (Spot Price = Strike Price).

Out of the money option is one where the call option has the spot price is less than the strike price (Spot Price < Strike Price).

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