In the present highly uncertain business scenario, the importance of risk management is much greater than ever before. The emergence of derivatives market is an ingenious feat of financial engineering that provides an effective and less costly solution to the problem of risk that is embedded in the price unpredictability of the underlying asset.

it has been found that introduction of derivative products not only deepens the markets but also plays an important role in reduction of volatility in the spot markets. Role of derivatives in stablising or destablising the cash market is a matter of debate and analytical research. It has been argued that, after the introduction of derivative market, well informed speculative traders might shift from cash market to derivative market as superior investment instruments. Obviously, superiority comes from inherent leverage and lower transaction cost.

Derivatives play a very critical role in the process of price discovery and in completing the market. Their role as a risk management tool clearly assumes that derivative trading does not increase market volatility and hence does not increase risk. Information flows from F&O segment to the cash market; the signal may be noisy to certain extent but market takes clue from the future market and tries to position itself accordingly.

Major Players

As derivative segment is very large in terms of volume and turn over compared to spot equity market, there are a whole lot of market participants who trade in this segment. They range from highly equipped FIIs, DIIs, HNIs to retail investors. Every participant has his/her own target and objective in mind to trade in derivative segment. Based on their targets and objectives, investors take positions and hence can be classified in different categories of investors. There are three major players in the financial derivatives trading.

Hedgers

Hedgers are traders who use derivatives to reduce the risk that they face from potential movements in a market variable. They want to avoid exposure to adverse movements in the price of an asset. Majority of the participants in derivatives market belongs to this category. Commodity markets are the place where participants tend to hedge their positions to avoid unwanted risk of adverse market movements.

Speculators

Speculators are traders who buy/sell the assets only to sell/buy them back profitably at a later point in time. Speculators want to assume risk. They use derivatives to bet on the future direction of the price of an asset and take a position in order to make a quick profit. They can increase both the potential gains and potential losses by usage of derivatives in a speculative venture. In derivative segment, highly leveraged positions can be taken depending upon the margin requirements it provides the fertile land for the speculators to take advantage. Risk and rewards both are very high in derivatives for speculators.

Arbitragers

Arbitragers are traders who simultaneously buy and sell the same (or different, but related) assets in an effort to profit from unrealistic price differentials. Arbitrageurs attempt to make profits by locking in a risk-less profit by simultaneously entering into transactions in two or more markets. They try to earn risk-less profits from discrepancies between futures and spot prices and among different futures prices. Whenever future’s price gets out of line with its spot price, there exists an arbitrage opportunity. To identify the arbitrage opportunity and to capture risk-less profit, arbitrageurs have to have required skill-set and the sophisticated tools to take advantage of the situation.