the Chicago Butter and Egg Board, a spin-off of CBOT, was reorganized to allow futures trading. Its name was changed to Chicago Mercantile Exchange (CME).The first stock index futures contract was traded at Kansas City Board of Trade. Currently the most popular stock index futures contract in the world is based on the Standard & Poor's 500 Index, traded on the CME. In April 1973, the Chicago Board of Options Exchange was set up specifically for the purpose of trading in options. The market for options developed so rapidly that by early 80s the number of shares underlying the option contract sold each day exceeded the daily volume of shares traded on the New York Stock Exchange. And there has been no looking back ever since.

The Securities and Exchange Board of India (SEBI) allowed trading in equities-based derivatives on stock exchanges in June 2000. Accordingly the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) introduced trading in futures on June 9, 2000 and June 12, 2000 respectively. Currently futures and options turnover on the NSE is Rs7,000-8,000 crore approximately. In India stock index options were introduced from July 2, 2001.

Derivatives are financial contracts whose value/price is dependent on the behavior of the price of one or more basic underlying assets (simply known as underlying). These contracts are legally binding agreements, made on the trading screen of stock exchanges, to buy or sell an asset in future. The asset can be a share, index, interest rate, bond, rupee/dollar exchange rate, sugar, crude oil, soyabean , cotton, coffee etc.

A forward contract is a customized contract between the buyer and the seller where settlement takes place on a specific date in future at a price agreed today.

Futures are exchange-traded contracts to buy or sell an asset in future at a price agreed upon today. The asset can be a share, index, interest, bond, rupee-dollar exchange rate, sugar, crude oil, soya bean, cotton, coffee etc.

Example : when you are dealing in March 2004 Satyam futures contract the market lot, i.e. the minimum quantity that you can buy or sell, is 1,200 shares of Satyam; the contract would expire on March 28, 2004; the price is quoted per share; the tick size is 5 paise per share or (1,200 * 0.05) = Rs60 per contract/market lot; the contract would be settled in cash; and the closing price in the cash market on the expiry day would be the settlement price.

Options are contracts that give the buyers the right (but not the obligation) to buy or sell a specified quantity of certain underlying assets at a specified price on or before a specified date. On the other hand, the seller is under obligation to perform the contract (buy or sell). The underlying asset can be a share, index, interest rate, bond, rupee-dollar exchange rate, sugar, crude oil, soya bean, cotton, coffee etc.
Example: suppose you have bought a call option of 2,000 shares of Hindustan Lever Ltd (HLL) at a strike price of Rs250 per share. This option gives you the right to buy 2,000 shares of HLL at Rs250 per share on or before March 28, 2004. The seller of this call option who has given you the right to buy from him is under the obligation to sell 2,000 shares of HLL at Rs250 per share on or before March 28, 2004 whenever asked.

Example: suppose you have bought a call option of 2,000 shares of Hindustan Lever Ltd (HLL) at a strike price of Rs250 per share. This option gives you the right to buy 2,000 shares of HLL at Rs250 per share on or before March 28, 2004. The seller of this call option who has given you the right to buy from him is under the obligation to sell 2,000 shares of HLL at Rs250 per share on or before March 28, 2004 whenever asked.

Example: suppose you bought a put option of 2,000 shares of HLL at a strike price of Rs250 per share. This option gives its buyer the right to sell 2,000 shares of HLL at Rs250 per share on or before March 28, 2004. The seller of this put option who has given you the right to sell to him is under obligation to buy 2,000 shares of HLL at Rs250 per share on or before March 28, 2004 whenever asked.

Option contracts ,which can be exercised on or before their expiry are called American options. All stock option contracts are American in style.

The options on the Nifty and Sensex are European style options--meaning that the buyer of these options can exercise his options only on the expiry day. He cannot exercise them before the expiry of the contracts as in case with options on stocks. As such the buyer of index options needs to square up his positions to get out of the market.

In India all stock options are American style options and index options are European style options.

Hedgers have a position in the underlying asset or are interested in buying the asset in the future. For example, a hedger could be an investor who has got funds to invest in stocks. Hedgers participate in the derivatives market to lock the prices at which they will be able to do the transaction in the future. Thus they are trying to avoid the price risk.

Speculators participate in the futures market to take up the price risk, which is avoided by the hedgers.

Arbitrageurs watch the spot and futures markets and whenever they spot a mismatch in the prices of the two markets they enter to get the extra profit in a risk-free transaction.