Understanding the Basics of Derivative Trading

Did you know that about 60% of all derivatives contracts traded globally in April 2025 were on the Indian equity derivatives market?

Derivatives can make you earn unlimited profits, but can also increase risks. However, understanding the different types and strategies of it helps you address the risks and make you profitable.

This simple guide breaks down derivative trading in simple words and highlights its types.

What is Derivative Trading?

Derivative trading is the process of deriving value from an underlying asset, such as equities, currencies, exchange rates, commodities, and interest rates. Both buyers and sellers estimate future trade prices differently, predicting the underlying assets’ future price. Traders must pay an initial margin payment to the stockbrokers for derivative trading.

There are mainly 4 types of derivatives trading: forward, futures, options, and swaps. However, futures and options are the most common types of derivatives traded in India.

What is a Futures Contract?

A futures contract provides the buyer and seller the right and the obligation to purchase and sell an asset at a predetermined price on a fixed date. Here is an example of futures trading:

You bought a futures contract for 50 shares of company X for INR 50 each. Regardless of the current price, you will receive the shares you committed to purchase for INR 50 when the contract expires, even if they have increased to INR 70. You have made a profit of INR 1,000 in this case.

However, you would still be purchasing each share at INR 50 if the share price has dropped to INR 30 at expiry. You will lose INR 1,000 in such a scenario.

What is an Options Contract?

An options contract is a derivative contract which gives the buyer and seller the right, but not the obligation, to buy or sell the asset at a fixed price on a future date. 

Call and put options are the two types of option contracts. The following examples can be used to demonstrate these:

• Call Option

A call option grants the buyer the right to buy a certain asset on a predetermined date at a specific price. Please take note that the buyer is under no obligation to purchase. For instance, you can withdraw from a call option you bought to buy 50 shares of company X at INR 50 a share on a specific date if the price of each share falls to INR 30 before the contract expires. 

In this case, you have lost a premium amount, which you must pay in options as a buyer. As a result, you have saved INR 1,000 in losses.

• Put Options

A put option gives the buyer the right to sell their shares at a set price on a certain date. You can purchase a put option to sell your company X’s shares for INR 50 at a later time. If the share price increases to INR 60 before your put option contract expires, you could decide not to sell your shares for INR 50. You keep yourself from losing here as well.

What are the Key Indicators in Options Trading?

In an options contract, implied volatility and historical volatility are two distinct methods of evaluating the possible price movements of an underlying asset. Implied volatility is an indicator of future price changes based on market expectations. Conversely, historical volatility is an indicator that looks backwards and captures previous price changes.

What are the Risks Involved in Derivatives Trading?

Final Thought

Derivative trading requires a high level of education and knowledge regarding its types. To maximise returns and avoid losses, investors must thoroughly understand the strategies and associated risks. Additionally, knowledge of market dynamics and employing risk management skills is crucial for successful trading.