Equity, Currency and Commodity Derivatives

Derivatives are financial instruments whose value is derived from an underlying asset such as a stock, a currency pair or a commodity. In the Indian market, the most widely traded derivatives are futures contracts, which obligate the holder to buy or sell the underlying at a pre‑determined price on a future date.

The NISM exam expects candidates to distinguish between the three broad categories – equity, currency and commodity futures – because each category follows different contract specifications, settlement mechanisms and regulatory nuances. Knowing these differences helps you answer both conceptual and calculation‑based questions.

From an advisory perspective, an Investment Adviser must assess the suitability of each derivative type for a client, taking into account risk tolerance, investment horizon and regulatory limits set by SEBI.

Derivatives are classified primarily by the nature of the underlying asset. Equity derivatives have shares or indices as their base, currency derivatives are based on foreign‑exchange pairs, and commodity derivatives involve physical commodities like gold, crude oil or agricultural produce.

Each class follows a specific contract unit (lot size), tick size, and settlement type (physical vs cash). For example, equity futures on the NSE are cash‑settled, whereas many commodity futures on the MCX are physically settled, meaning the actual commodity may be delivered on expiry.

Exam questions often test your ability to match a contract specification to its derivative class, so memorising the typical lot sizes and settlement methods is crucial.

Equity futures allow investors to take a position on the future price of a listed share or an index such as NIFTY 50. The contract unit is defined in terms of the number of shares (e.g., 75 shares per lot for Reliance Industries). The tick size is typically ₹0.05 per share, translating to a monetary tick value of ₹3.75 per lot.

Because settlement is cash‑based, no physical delivery of shares occurs at expiry. Instead, the final cash settlement amount equals the difference between the futures price at expiry and the spot price of the underlying, multiplied by the contract size.

Advisors use equity futures for directional bets, hedging equity exposure, or arbitrage. The exam often asks for the calculation of profit/loss, margin requirement, or the effect of a change in spot price on the futures price.

Currency futures are contracts on foreign‑exchange pairs, the most common being USD/INR. The contract unit is expressed in foreign currency (e.g., 12,500 USD per lot). The tick size is usually 0.05 INR per USD, giving a monetary tick value of ₹625 per lot.

All Indian currency futures are cash‑settled, and the settlement price is the closing spot rate on the expiry day as declared by the exchange. This eliminates the need for actual currency delivery, simplifying the process for Indian investors.

Key exam topics include calculating the mark‑to‑market (MTM) impact of exchange‑rate movements, understanding the role of forward points, and recognising SEBI’s position limits for currency contracts.

Commodity futures cover a wide range of physical goods, from precious metals like gold to energy products such as crude oil, and agricultural items like wheat. The contract unit varies by commodity – for gold it is 1 kg per lot, for crude oil it is 1 metric tonne.

Unlike equity and currency futures, many commodity contracts on the Multi Commodity Exchange (MCX) are physically settled. If a trader holds a long position until expiry, they must arrange for delivery of the commodity, unless they close the position beforehand.

Exam questions may test you on the distinction between cash‑settled and physically settled contracts, the impact of storage costs (known as "carry"), and the calculation of the futures price using the cost‑of‑carry model.

The cost‑of‑carry model links the futures price to the spot price by accounting for financing cost (r), storage or holding cost (u), and any benefit from holding the asset such as dividends or convenience yield (d). For equity futures, the dividend yield replaces the convenience yield, while for commodities, storage costs dominate.

In the NISM exam, you may be given the spot price, interest rate and dividend yield and asked to compute the fair futures price. Remember to convert percentages to decimals and to adjust the time to expiry in years (e.g., 3 months = 0.25 years).

Common mistakes include forgetting to subtract the dividend yield for equity futures or using a daily rate instead of an annual rate. The formula above is the only one you need for pricing calculations in this sub‑topic.

Futures contracts are marked‑to‑market daily. The MTM profit or loss equals the change in the futures price multiplied by the contract size. If the price moves in your favour, the exchange credits your account; if it moves against you, the amount is debited.

Initial margin is the security deposit required to open a position, while variation margin covers daily MTM fluctuations. SEBI mandates a minimum initial margin of 5‑10% of the contract value for most futures, but the exact percentage is set by the exchange.

Exam questions often present a scenario with an opening futures price, a closing price, and the contract size, asking you to compute the net profit or loss and the resulting margin balance.

SEBI regulates all derivatives trading in India through the Securities and Exchange Board of India (Derivatives) Regulations, 2016. Key provisions include mandatory client eligibility criteria, position limits, and the requirement for clearing members to maintain a default fund.

Advisors must ensure that clients are classified as "qualified investors" for commodity futures and must disclose the risks associated with leverage. The exam frequently asks for the statutory minimum margin, the role of the clearing corporation, or the penalty for breach of position limits.

Memory aid: "C‑L‑P" – Clearing corporation, Leverage limits, Position limits. Remember these three pillars when answering regulation‑related questions.