π NISM Series VIII β Equity Derivatives Certification
Comprehensive Study Guide | NSE / SEBI Certified Examination
β οΈ DISCLAIMER: This resource is for educational purposes only and does not constitute legal or financial advice.
Always refer to official NISM / SEBI publications for examination purposes.
π Chapter 1: Basics of Derivatives
1.1 What is a Derivative?
A derivative is a financial contract whose value is derived from an underlying asset β it has no value of its own! Think of it like a bet on the future price of something.
- Value comes from an underlying asset (stocks, indices, gold, oil, etc.)
- It is a contract between two parties for a future transaction
- Used for hedging (protection), speculation (profit), and arbitrage (risk-free profit)
- Traded on exchanges (NSE/BSE) or Over-The-Counter (OTC)
1.2 Types of Underlying Assets
| Category | Examples | India Context |
|---|---|---|
| Equity | Stocks, Indices | Nifty50, Reliance, TCS |
| Commodity | Metals, Energy, Agriculture | Gold, Crude Oil, Wheat |
| Financial | Interest rates, Currencies | USD/INR, 10-yr G-Sec |
| Weather | Temperature, Rainfall | Less common in India |
1.3 Types of Derivative Contracts
- Forwards β Private, customized OTC contracts. Counterparty risk exists.
- Futures β Standardized, exchange-traded, daily MTM settlement.
- Options β Right (not obligation) to buy/sell at a preset price.
- Swaps β Exchange of cash flows (interest rate/currency). Mostly OTC.
1.4 Market Participants
| Participant | Purpose | Example |
|---|---|---|
| Hedger | Protection from price risk | Airline hedging fuel cost |
| Speculator | Profit from price movement | Retail trader buying calls |
| Arbitrageur | Risk-free profit from price difference | Buying spot, selling futures |
| Market Maker | Provide liquidity, quote buy/sell | Broker on NSE |
1.5 Exchange-Traded vs OTC
| Feature | Exchange-Traded (ET) | Over-The-Counter (OTC) |
|---|---|---|
| Standardization | Fully standardized | Customized |
| Counterparty Risk | Nil (cleared by NSCCL) | High |
| Transparency | High (public prices) | Low |
| Regulation | SEBI regulated | Less regulated |
| Example | Nifty Futures on NSE | Currency forwards (banks) |
π Chapter 2: Equity Indices
2.1 What is an Equity Index?
An index is a basket of stocks that represents the market or a sector. It's like a report card for the stock market!
- Nifty 50 β Top 50 companies on NSE (most popular in India)
- Sensex β Top 30 companies on BSE
- Used as benchmark for portfolio performance
- Basis for index futures and options
2.2 Index Weighting Methods
| Method | How It Works | India Example |
|---|---|---|
| Market-Cap Weighted | Weight = Market Cap of company | Nifty 50 |
| Free-Float Weighted | Only publicly traded shares count | Sensex (post 2003) |
| Price-Weighted | Higher priced stock = more weight | Dow Jones (USA) |
| Equal-Weighted | Every stock has same weight | Nifty Equal Weight |
2.3 Impact Cost
- Measures the cost of executing a trade in the market
- Higher impact cost = less liquid stock
- Used by NSE to decide if a stock qualifies for F&O segment
- Formula: Impact Cost = (Actual Buy Price β Ideal Price) / Ideal Price Γ 100
2.4 Applications of Index
| Application | Description |
|---|---|
| Index Funds | Mutual funds that replicate the index |
| ETFs | Exchange Traded Funds tracking an index |
| Index Derivatives | Futures & Options on Nifty, Sensex etc. |
| Benchmark | Compare portfolio return vs index return |
π Chapter 3: Forwards and Futures
3.1 Forwards vs Futures β Key Differences
| Feature | Forward Contract | Futures Contract |
|---|---|---|
| Trading Venue | OTC (banks, private) | Exchange (NSE/BSE) |
| Standardization | Customized (any size, date) | Standardized (lot size, expiry) |
| Settlement | At expiry only | Daily MTM + Final |
| Counterparty Risk | High | None (NSCCL guarantees) |
| Margin Required | No | Yes (SPAN + Exposure) |
| Liquidity | Low | High |
3.2 Important Terminology
- Basis = Spot Price β Futures Price (Negative basis = Contango; Positive = Backwardation)
- Cost of Carry = Cost to hold the underlying asset till expiry (interest + storage β dividends)
- Open Interest (OI) = Total outstanding contracts not yet settled
- MTM (Mark to Market) = Daily profit/loss settlement based on closing price
- Lot Size = Minimum quantity for one futures contract
- Expiry = Last Thursday of every month (monthly contracts)
3.3 Futures Pricing Models
| Model | Formula / Concept |
|---|---|
| Cost of Carry Model | F = S Γ e^(rT) or F = S (1 + r)^T |
| Expectations Hypothesis | Futures price = Expected future spot price |
| Convenience Yield | For commodities: benefit of holding physical asset |
3.4 Margins in Futures
- Initial Margin β Deposit before trading (SPAN calculated)
- Maintenance Margin β Minimum balance to maintain
- Mark-to-Market Margin β Daily loss deducted from account
- Exposure Margin β Additional buffer (3% for index, 5% for stocks)
- Margin Call β Broker demands top-up when balance falls below maintenance
βοΈ Chapter 4: Options Mechanism
4.1 What is an Option?
An option gives the buyer the RIGHT (not obligation) to buy or sell an asset at a fixed price (Strike Price) on or before expiry. The seller has the obligation to fulfill if exercised.
4.2 Call vs Put Options
| Feature | Call Option | Put Option |
|---|---|---|
| Right to | BUY the underlying | SELL the underlying |
| Buyer profits when | Price RISES above strike | Price FALLS below strike |
| Seller profits when | Price stays BELOW strike | Price stays ABOVE strike |
| Max buyer loss | Premium paid | Premium paid |
| Max seller loss | Unlimited | Strike β Premium |
4.3 Moneyness of Options
| Status | Call Option | Put Option |
|---|---|---|
| In-the-Money (ITM) | Spot > Strike | Spot < Strike |
| At-the-Money (ATM) | Spot β Strike | Spot β Strike |
| Out-of-the-Money (OTM) | Spot < Strike | Spot > Strike |
4.4 Option Greeks (Sensitivity Measures)
| Greek | What It Measures | Simple Explanation |
|---|---|---|
| Delta (Ξ) | Change in option price per βΉ1 change in spot | Speed of the option |
| Gamma (Ξ) | Rate of change of Delta | Acceleration of option |
| Theta (Ξ) | Time decay β option loses value daily | Enemy of option buyers |
| Vega (Ξ½) | Change due to volatility | Sensitivity to fear/uncertainty |
| Rho (Ο) | Change due to interest rate change | Least important Greek |
4.5 Factors Affecting Option Pricing
- Spot Price β Higher spot = higher call value, lower put value
- Strike Price β OTM options are cheaper than ITM options
- Time to Expiry β More time = more premium (time value)
- Volatility β Higher volatility = higher premium for both calls and puts
- Interest Rate β Higher rates = slightly higher call, lower put
- Dividends β Expected dividend = lower call, higher put
4.6 Option Pricing Models
- Black-Scholes Model (BSM) β For European options (exercised only at expiry)
- Binomial Model β Tree-based model for American options (exercised anytime)
- Put-Call Parity β C β P = S β PV(K) (for European options)
π― Chapter 5: Trading Strategies
5.1 Spread Strategies (Vertical Spreads)
| Strategy | Action | Market View | Max Profit |
|---|---|---|---|
| Bull Call Spread | Buy lower call + Sell higher call | Mildly Bullish | Difference in strikes β Net Premium |
| Bear Put Spread | Buy higher put + Sell lower put | Mildly Bearish | Difference in strikes β Net Premium |
| Bull Put Spread | Sell higher put + Buy lower put | Mildly Bullish | Net Premium received |
| Bear Call Spread | Sell lower call + Buy higher call | Mildly Bearish | Net Premium received |
5.2 Volatility Strategies
| Strategy | Action | Profit When |
|---|---|---|
| Long Straddle | Buy ATM Call + Buy ATM Put (same strike) | Big move either direction |
| Short Straddle | Sell ATM Call + Sell ATM Put | Market stays range-bound |
| Long Strangle | Buy OTM Call + Buy OTM Put | Very big move (cheaper than straddle) |
| Long Butterfly | Buy 1 ITM Call + Sell 2 ATM Calls + Buy 1 OTM Call | Market stays near ATM strike |
5.3 Hedging Strategies
- Covered Call β Own shares + Sell call. Earn extra income in sideways market.
- Protective Put β Own shares + Buy put. Insurance against falling prices.
- Collar β Own shares + Buy put + Sell call. Low-cost protection with capped upside.
- Portfolio Hedging β Sell index futures to hedge entire portfolio.
5.4 Arbitrage Strategies
- Cash & Carry Arbitrage β Buy spot + Sell futures when futures > Fair Value
- Reverse Cash & Carry β Sell spot + Buy futures when futures < Spot Price
- Put-Call Parity Arbitrage β Exploit mispricing between calls, puts and forwards
- Calendar Spread Arbitrage β Exploit price difference between near and far expiry
π¦ Chapter 6: Trading & Clearing
6.1 Key Entities in F&O Market
| Entity | Role |
|---|---|
| NSE / BSE | Exchange β provides platform for trading |
| NSCCL | Clearing Corporation β guarantees settlement, manages risk |
| Trading Member (TM) | SEBI-registered broker through whom orders are placed |
| Clearing Member (CM) | Clears and settles trades with NSCCL |
| Professional Clearing Member (PCM) | Only clears β does not trade directly |
| Custodians | Hold securities on behalf of institutional investors |
6.2 Order Types
| Order Type | Description |
|---|---|
| Limit Order | Execute only at specified price or better |
| Market Order | Execute immediately at best available price |
| Stop-Loss Order | Triggers when price hits stop level to limit loss |
| Day Order | Valid only for the trading day |
| IOC (Immediate or Cancel) | Execute immediately; cancel unfilled part |
| GTC (Good Till Cancel) | Valid till cancelled by trader |
6.3 Risk Management β SPAN Margining
- SPAN β Standard Portfolio Analysis of Risk. Calculates worst-case loss over 1 day.
- VaR Margin β Value at Risk β based on 99% confidence level
- Exposure Margin β Extra buffer over SPAN (3% index / 5% stocks)
- Premium Margin β Collected from option buyers = premium amount
- Assignment Margin β For option sellers upon exercise/assignment
6.4 Settlement Types
| Instrument | Settlement Type | How |
|---|---|---|
| Index Futures/Options | Cash Settlement | P&L settled in cash at expiry (EDSP) |
| Stock Futures/Options | Physical Delivery | Actual shares delivered (since Oct 2019) |
| Daily MTM | Cash | Profit/loss debited/credited daily |
βοΈ Chapter 7: Regulatory & Compliance Framework
7.1 Key Laws and Acts
| Act / Law | Year | Significance |
|---|---|---|
| SCRA (Securities Contracts Regulation Act) | 1956 | Governs trading in securities and derivatives in India |
| SEBI Act | 1992 | Established SEBI; protects investors, develops securities market |
| PMLA (Prevention of Money Laundering Act) | 2002 | Anti-money laundering; requires KYC, STR, CTR reporting |
| Depositories Act | 1996 | Enables holding securities in electronic (demat) form |
7.2 SEBI's Role
- Regulates all market participants β exchanges, brokers, FIIs, mutual funds
- Issues circulars on margin requirements, position limits, disclosure norms
- Operates SCORES portal for investor grievance redressal
- Mandates Risk Disclosure Document (RDD) to be signed by F&O clients
- Sets position limits for individual traders, FIIs, members
7.3 Anti-Money Laundering (AML) & KYC
| Requirement | What It Means |
|---|---|
| KYC (Know Your Customer) | Verify client identity before opening trading account |
| CDD (Client Due Diligence) | Ongoing monitoring of client activity |
| STR (Suspicious Transaction Report) | Report unusual/suspicious transactions to FIU-IND |
| CTR (Cash Transaction Report) | Report cash transactions above βΉ10 lakh |
| PEP (Politically Exposed Person) | Requires enhanced due diligence |
7.4 Taxation on Derivatives
- F&O income is treated as Business Income (not capital gains)
- STT (Securities Transaction Tax) is collected by exchange at point of transaction
- Losses from F&O can be set off against any business income
- No STT on open positions at expiry (only on premium for options)
- ITR-3 form is required to declare F&O income/loss
7.5 Investor Protection Measures
- SCORES Portal β SEBI Complaints Redressal System (online grievance)
- ODR Portal β Online Dispute Resolution between investor and broker
- Risk Disclosure Document β Mandatory for F&O clients to read and sign
- Investor Protection Fund (IPF) β Compensates investors in case of broker default
π Trading Lifecycle β Flowchart
This flowchart shows the complete lifecycle of an Equity Derivatives trade β from investor decision all the way to final settlement.
π§ NISM Series VIII β Mind Map
Visual overview of all major topics in NISM Series VIII arranged as a mind map with center node and branches.
πΊοΈ Study Roadmap β NISM Series VIII
Follow this 8-step roadmap to systematically prepare for and pass the NISM Series VIII Equity Derivatives certification.
π EDUCATIONAL DISCLAIMER: This resource is for educational purposes only and does not constitute legal or financial advice.
Content is based on NISM Series VIII curriculum. Always consult the official NISM workbook and SEBI circulars for exam preparation.
Β© NISM Study Guide β For Academic Use Only.