What is Equity Derivative?
- 22nd July 2025
- 11:00:00 AM
- 7 min read
With growing volatility in the Indian securities market, understanding equity derivatives is no longer optional; it is essential. These financial instruments derive their value from underlying assets like stocks and are widely used to hedge risks, speculate on price movements, and optimise investment portfolios.
India accounts for 60% of the global derivatives market, with 7.3 billion trades recorded in April 2025 alone. Curious about how they work? Read this blog to explore their types, trading strategies, and much more.
4 Common Types of Equity Derivatives
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Futures Contract
This is a financial contract between a buyer and a seller of an underlying equity asset to buy or sell the asset at a predetermined price and date. These are traded across recognised stock exchanges like the NSE. At the NSE, 224 stocks are available for future contracts in 2025.
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Options
If you opt for an option contract, you can buy or sell an underlying equity asset at a predetermined price or date without obligation to exercise the option. Suppose buying a call option on a stock trading at INR 100, at a strike price of INR 100, speculating on an increase in the next month. If the price increases to INR 120, you exercise the option and buy at the strike price and make a profit.
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Forwards
Forward contracts are another form of an equity derivative, but come with an obligation to exercise them on the specified date. Unlike futures or options, forwards are not traded across exchanges but are available at the over-the-counter (OTC) market.
- SwapsSimilar to forward contracts, you can fund equity swaps in the OTC market. It is a private agreement when one party exchanges cash flows from equity assets, like a stock. Another party exchanges cash flow based on a floating or fixed interest.
How are Equity Derivatives Settled?
When you opt for a derivative like the futures or options, you agree to the terms and conditions of those contracts with an exchange like the NSE. Considering the clearing and settlement of those contracts after exercising them, a clearing house takes this responsibility.
For example, when you get into a derivative contract at the NSE, the National Securities Clearing Corporation Limited (NSCCL) is your clearing and settlement agency.
They play the role of a legal counterparty for the deals under the derivatives segment and ensure settlements. Taking a deeper look into the settlement, a clearing member of the agency clears and settles the deals under the futures and options segment.
However, for the derivatives from the OTC market, derivatives are settled on a bilateral basis between the buyer and seller of the contracts.
Why Should You Invest in Equity Derivatives?
Take note of the following advantages of these derivatives to make an informed investment decision after understanding the equity derivative definition:
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Helps Managing Risks
Investors use equity derivatives as a hedging tool against price fluctuations. Derivatives, such as futures and options safeguard portfolios from adverse market movements. As an instance, due to recent geopolitical tension in the Middle East, both the BSE and the NSE indices fell by 823.16 and 253.20 points. Such derivatives become effective in such scenarios.
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Diversification
Once again, diversification is another approach to add a cushion to your investments against unexpected or negative market movements. Apart from sticking to one type of asset, investments in equity derivatives allow you exposure to a variety of equities without even buying a particular stock.
- Benefits of LeverageAn equity derivative needs less upfront capital compared to buying an asset, like a stock, directly. This allows you to control a large position in the market at a nominal amount. For example, instead of buying 100 shares at INR 150 each at INR 1,50,000, you can enter into a future contract by paying only a premium of INR 10,000 to increase your return potential.
- Allows SpeculationSuch derivatives allow you to speculate on the price movement of the assets. Thus, you can gain profit when the price of the assets or stocks goes up or down. To put it simply, when you speculate that the price of underlying assets will rise, you buy a call option. Conversely, when you speculate on a price drop, you can get a put option to make a profit.
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Risks in Equity Derivative Investments
Now that you have an idea about what is equity derivative, let us explore some of its disadvantages:
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Complexity
Although trading in derivatives allows for an optimised profit and protects against risks, using it as an investment option is tricky. This is due to its complexity, which makes it a little bit harder to master than trading in stocks directly.
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A Higher Risk of Loss
With a potential for higher earnings, trading in derivatives of equities also has a high potential for making losses. This is especially true if the market moves sharply against the position of investors. The recent report by SEBI indicates that investors in the equity derivatives segment lost INR 1,05,603 in total in the financial year of 2025.
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Risk from the Counterparties
As per the equity derivative meaning and types, you know that you can get in derivative contracts both at exchanges and the OTC market. However, getting into an OTC-traded contract comes with a default risk. If you get into swap or forward contracts from OTC, the other party might fail or default on their contractual obligation, resulting in losses.
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Costs
When you get into a derivative contract, you must pay for additional factors that reduce your overall profit. These include fees, commission and transaction costs that get included in the actual investment, which impact frequent traders.
Conclusion
Understanding the concept of an equity derivative is important for you as an investor. You can hold a larger position in the market by paying only a nominal premium. This also helps you hedge against market fluctuations. You can take appropriate investment actions by speculating on the price movement of assets and making a profit.
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FAQ’s
1. Who regulates derivatives?
The Securities and Exchange Board of India, or SEBI, regulates derivatives trading in the Indian securities market.
2. What is the difference between equities and equity derivatives?
When you buy equity in a company, you get an ownership unit of that company. When you invest in an equity derivative, it allows you to capitalise on the price movement of the underlying stock. You do not need to own a stock in this case.
3. Is physical settlement available for equity derivatives?
Yes, in equity derivatives, the option of physical settlement is available. As a buyer of a derivative contract, you can take the physical delivery of the underlying shares. You get the delivery of shares directly to your Demat account.
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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
