The Derivatives Market serves as the sophisticated motor room of the financial industry, creating mechanisms for hedging, speculating, and arbitrage. Anyone who wants to pursue a career in finance, either as an approved user of the platform, a dealer on the platform, or a research analyst, must be familiarized with this segment of the financial markets. In particular, the NCFM Derivatives Market Trading module (as well, the Derivatives Market Dealers Module) is the benchmark. This guide will highlight the absolute key topic you should focus on to not only pass the certification but also know what's going on, adding to your financial knowledge of Futures and Options trading.
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What is the Derivatives Market?
The Derivatives Market is a market in which financial instruments, called derivatives, whose value is determined by an underlying asset, are traded. In India, the major categories of derivatives traded are Equity Derivatives, which are based on stocks and indices such as Nifty and Sensex, Currency Derivatives, and Commodity Derivatives.
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The main principle to know surrounds the distinction between the two primary financial instruments:
Futures Contracts: This agreement involves buying or selling an asset at a previously determined price on a specific date. This creates an obligation for both buyer and seller. Understanding this instrument is critical for anyone learning how to Start Trading in the Derivatives Market and is the primary knowledge framework for the entire Derivatives Market.
Options Contracts: Allow the buyer the right, but not the obligation, to purchase (Call Option) or sell (Put Option) an underlying asset for a predetermined exercise price (Strike Price) at or prior to a specific date.
Further Study: To begin building a foundational understanding of options, study the market that the underlying assets are traded in (Equity Market Basics).
To start your market journey, consider taking the introductory course, Financial Market Beginners Module.
Understanding Options - Theory and Payoffs
Options are probably the most complex and highest tested topic in any NCFM Derivatives Market Trading certification. A good command of options terminology, pricing, and payoff profiles is paramount.
Find out the Option Trading Strategies.
Key Terms and Concepts
Moneyness (ITM, ATM, OTM): It is important as a trader to understand when a Call or Put option is In-The-Money (ITM), At-The-Money (ATM), or Out-Of-The-Money (OTM), as it will assist with finding the intrinsic value of the option.
Strike Price and Premium: The strike price is the exercise price, and the premium is how much I paid for the option (the cost).
Put/Call Parity: is the fundamental theoretical relationship of the price of European Call options, Put options, the underlying stock price, and the forward price. This is often used in arbitrage price relationships.
Payoff Profiles
Strategies and Risk Management
Effectively operating in the Derivatives Market involves both well-defined strategies and strict risk control. The NCFM Derivatives Hot Topics strongly emphasizes practical applications.
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1. Options Strategies
Options strategies go beyond just combinations of buying/selling options to include combinations of more than one option or one option and the underlying, so risk and reward can be defined.
Spreads (Vertical, Horizontal): A strategy that is used to lower premium cost or limit risk, which might include a Bull Call Spread or Bear Put Spread.
Combinations: A strategy that includes the Straddle (where a long Call and long Put are held simultaneously at the same strike) or a Strangle (holding a long Call and long Put at different strikes) to capture return from high volatility or a sideways-moving market.
Further Study: For practical usage of these, see Derivative Trading Strategies and Best Options Trading Strategies.
2. The Option Greeks
These are measures of the option's sensitivity to various factors. If you are going to be engaged in a professional environment of risk management, it is imperative that you have knowledge of the Option Greeks.
Delta - Measures the change in the price of the option for a 1 unit change of the underlying asset's price. Delta also measures the statistical probability of price increase above the strike price and the option expiring in-the-money (ITM).
Theta - Measures the rate of decay of the value of the option as time progresses. Time decay is the constant foe of an option buyer.
Vega - Measures the sensitivity to changes in the underlying asset’s volatility.
Gamma - Measures the rate of change of Delta.
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3. Risk Management in Derivatives
The high level of leverage in derivatives trading means managing risk is incredibly important.
Margin Requirements: Initial and Maintenance Margins are deposits that need to be made to ensure that each party will perform its side of the contract.
Mark-to-Market (MTM): Futures are marked-to-market daily on the basis of the closing price, which is one of the ways to mitigate counterparty risk.
Hedging: This refers to using derivatives to hedge risk in a pre-existing portfolio. A high-priority topic is Understanding What is Hedging in Derivatives?
Regulatory and Operational Environment
You cannot discuss NCFM Derivatives Market Trading without at least addressing the Indian regulatory regime. The rules that govern the market and protect investors shape how the market operates.
SEBI Regulations: The market operates under the heavy watch of the Securities and Exchange Board of India (SEBI). It is important to get acquainted with the rules that govern trade practices as well as disclosures.
Clearing and Settlement: The National Securities Clearing Corporation Limited (NSCCL) is the central counterparty for exchange-traded derivatives and guarantees the performance of all trades and deals with defaults. You must understand what the final settlement procedure looks like for Futures (the cash settlement) and Options (exercise and assignment).
Position Limits: Regulatory restrictions applied to the maximum size of contracts an individual or other entity can hold. The reason is to limit speculation and market manipulation.
Further Study: Get yourself acquainted with the requirements of obtaining a license indirectly related to your career path: What is NISM Certification? and Common Questions in SEBI NISM Certification Exams.
To reinforce your knowledge, you should use a dedicated practice resource: Derivatives Market Dealers Mock Test.
Conclusion
In order to succeed in the Derivatives Market Trading segment, you need a combination of knowledge from theory (Options Pricing, Greeks), a good ability to think strategically (Spreads, Combinations), and a healthy respect for risk management (Margins, Hedging). By preparing for these NCFM Derivatives Key Topics, you will be revealing many of the tools you will eventually use to fulfill your career paths in the fast-paced finance career.
Begin with the basics, spend considerable time solving various numerical problems, and make use of the mock papers to test your knowledge. Your pathway to a competent derivatives professional starts now!
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