Equity Derivatives
CH6 · Trading Mechanism
All derivatives trading in India = screen-based (mandated by SEBI)
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Theme 6
Read order types, member categories, trading hours, margins, price bands and position limits.
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Equity Derivatives
All derivatives trading in India = screen-based (mandated by SEBI)
Currency Derivatives
Order types, trading hours, operating ranges, algo controls
Interest Rate Derivatives
Trading members, order types, price bands, SPAN, VaR and position limits
Detailed notes
Equity Derivatives
All derivatives trading in India = screen-based (mandated by SEBI)
NISM Series VIII — Equity Derivatives | 10% weightage | ~10 exam questions
This chapter is about the plumbing of the derivatives market — how orders are placed, how trades are executed, what the different order types are, and what it costs to trade. It's practical, operational knowledge. The exam tests terminology precisely — the difference between a limit order and a stop loss order, what tick size means, what impact cost is. Clean definitions, no numericals (except one stop loss calculation type). Good chapter to score full marks on.
Screen-based trading — all derivatives trading in India happens on electronic screens, not open outcry. This means:
Order types — heavily tested:
Market Order — execute immediately at whatever price is available. Speed over price.
Limit Order — execute only at your specified price or better. You set the price ceiling (for buy) or floor (for sell). May not execute if market doesn't reach your price.
Stop Loss Order — triggered when price reaches a specified level (trigger price), then releases as market order.
IOC (Immediate or Cancel) — execute whatever portion is available immediately, cancel the rest. No partial orders sitting in the book.
GTC (Good Till Cancelled) — order stays active until you cancel it. Valid up to 365 days.
Day Order — valid only for the trading day. Auto-cancelled at end of day if unexecuted.
Tick Size — minimum permitted price movement in a contract. For Nifty futures = ₹0.05 (5 paise). You can't quote ₹24,000.03 — the next valid quote after ₹24,000.00 is ₹24,000.05.
Circuit Filters / Price Limits — maximum permitted price movement in a day. All orders must be placed within these limits. Exchange sets them.
Market Maker — entity that continuously provides both buy AND sell quotes (two-way quotes) for a contract, ensuring liquidity. Earns the bid-ask spread.
Bid Price — highest price a buyer is willing to pay. ALWAYS lower than ask price. Ask Price — lowest price a seller is willing to accept. ALWAYS higher than bid price.
Impact Cost — the practical cost of executing a large order due to market illiquidity. High impact cost means the market is illiquid — large orders move the price adversely.
Position Limits — maximum exposure any single participant (client, trading member, or market) can take in a contract. Set by SEBI. Clearing corporation monitors and enforces. Trading member can set sub-limits for their own clients.
Algo Trading — automated trading using pre-programmed strategies. Allowed on Indian exchanges with regulatory approval.
You buy 100 shares of ABC at ₹980. You don't want to lose more than ₹1,000 on this position.
Maximum loss per share = ₹1,000 ÷ 100 shares = ₹10 per share
Stop loss trigger price = ₹980 − ₹10 = ₹970
Place a stop loss sell order at ₹970. If ABC falls to ₹970, the order triggers and you exit, limiting your loss to ₹1,000.
Common wrong answer: ₹990 (₹10 above instead of below). Always subtract for a long position stop loss.
Trap 1: "High impact cost is beneficial to arbitrageurs" → FALSE High impact cost is beneficial to NOBODY — not buyers, not sellers, not arbitrageurs. It makes execution expensive for everyone. The correct answer is "neither buyers nor sellers."
Trap 2: "Tick size is the maximum permitted price movement" → FALSE Tick size is the MINIMUM permitted price movement. Maximum daily movement is the circuit filter/price limit.
Trap 3: "IOC order unmatched portion goes into the order book" → FALSE IOC = Immediate or Cancel. Whatever doesn't execute IMMEDIATELY is CANCELLED. Nothing sits in the book.
Trap 4: "Day orders are executed the next trading day if unexecuted today" → FALSE Day orders are CANCELLED automatically at the end of the trading day. They do not roll over.
Trap 5: "Screen-based trading reduces transparency" → FALSE Screen-based trading INCREASES transparency — every price is visible to all participants simultaneously. The big advantage over floor trading is transparency.
Trap 6: "More participants in a market = lower liquidity" → FALSE More participants = higher liquidity. More buyers and sellers = tighter spreads = easier execution.
The exam always gives you:
Formula:
Loss per unit = Total acceptable loss ÷ Number of units
Stop loss price (long) = Entry price − Loss per unit
Stop loss price (short) = Entry price + Loss per unit10% of exam = ~10 questions. Mostly definitions and one stop loss calculation. Order types and impact cost are the most frequently tested. Zero numericals beyond stop loss math which is simple arithmetic.
Currency Derivatives
Order types, trading hours, operating ranges, algo controls
NISM Series I — Currency Derivatives | ~11% weightage | ~73 questions
Same structure as Series VIII CH6 but with currency-specific details. Order types, operating ranges, position limits, pro account rules, and FIFO — all tested here. The unique currency additions: operating ranges are ±3%/±5% (not circuit filters), expiry is at 12:30 PM (not 3:30 PM), and market timings are 9 AM to 5 PM. Know the differences from equity and you'll score full marks.
Limit order: Execute at specified price or BETTER. Buy limit = specified price or LOWER. Sell limit = specified price or HIGHER. May not execute if market doesn't reach the price.
Market order: Execute immediately at best available price. Trading system determines the price — not the trader.
Stop Loss Buy: Protects a short position. Trigger price < Limit price. When market rises to trigger, releases a limit buy order at or below limit price.
Stop Loss Sell: Protects a long position. Trigger price > Limit price. When market falls to trigger, releases a limit sell order.
IOC (Immediate or Cancel): Execute available quantity immediately, cancel the rest. Partial fills allowed. Nothing stays in the order book.
Day order: Valid for the trading day only. Auto-cancelled at end of day.
GTC (Good Till Cancelled): Stays active until cancelled (up to 365 days).
Active vs Passive orders: All orders enter as ACTIVE. If matched immediately → executed. If unmatched → becomes PASSIVE (sits in order book by price and time priority).
To prevent erroneous order entry:
Example: Base price GBPINR = Rs 100, contract = 1 month (≤6M) Operating range = 100 ± 3% = 97 to 103
For options: operating range based on DELTA (not fixed %).
Market timing: 9:00 AM to 5:00 PM (currency options excluding cross-currency) Cross-currency pairs (EURUSD, GBPUSD, USDJPY): can trade up to 7:30 PM
Expiry day: Trading ceases at 12:30 PM (not 5:00 PM as on normal days)
Expiry date: Two working days PRIOR to last business day of expiry month
Example: Last business day of April 2025 = 30th (Friday). Two working days before: 30th = Friday (last business day) 29th = Thursday (1 working day prior) 28th = Wednesday (2 working days prior) → expiry = 28th April
If Monday 29th is a holiday: 30th = Friday, 29th = holiday, 28th = Sunday, 27th = Saturday, 26th = Friday → expiry = 25th Thursday
Maximum maturity: 12 months for all INR pairs (USDINR, EURINR, GBPINR, JPYINR)
Positions monitored during day based on: Total open interest at END OF PREVIOUS DAY — not real-time, not the current day.
Pro account (proprietary trading): TM can place pro-account orders from ONE approved location. For multiple locations: must request exchange permission case-by-case. Exchange (not SEBI, not Clearing Corporation) approves.
Algorithmic trading: Any order generated using automated execution logic. Requires exchange approval. Day order can be placed via algo.
Contract notes: Broker must issue WITHOUT DELAY to clients in the FORMAT SPECIFIED BY THE EXCHANGE.
Maximum brokerage:
Base minimum capital:
When multiple contracts of the same series are outstanding and some are squared off, P&L is calculated using FIRST IN FIRST OUT. The price of the EARLIEST contract purchased is used first.
A trader sells USDINR futures at 86.50/86.70. The current market price is 86.80. They enter a limit sell order at 86.50. Since the best available buy order is at 86.60 (higher than their limit), the order will execute at 86.60 — at or above their limit price.
A stop-loss order: Trader is long USDINR at 84. Places stop loss sell order with trigger = 83.50, limit = 83.25. When USDINR falls to 83.50, the stop triggers and a limit sell order at 83.25 is released. Trigger > Limit for stop loss sell.
Trap 1: "Currency futures trading hours are 9 AM to 7:30 PM" — PARTIAL INR pairs (USDINR, EURINR, GBPINR, JPYINR) trade 9 AM to 5 PM. Cross-currency pairs (EURUSD, GBPUSD, USDJPY) trade 9 AM to 7:30 PM.
Trap 2: "Operating range = circuit filter" — Different terminology For equities it's called circuit filter/price band. For currency futures it's called "operating range." Same concept, different name.
Trap 3: "Day order carried forward to next day if unexecuted" — FALSE Day order is cancelled at end of day automatically. Only GTC stays active till cancelled.
Trap 4: "Pro account orders can be from multiple terminals freely" — FALSE One approved location by default. Need exchange permission for multiple locations.
Trap 5: "Stop loss buy: trigger > limit" — FALSE for buy Stop loss BUY: trigger < limit (trigger price is lower, you want to buy once it gets there). Stop loss SELL: trigger > limit.
Trap 6: "Position limits monitored on real-time open interest" — FALSE Monitoring uses previous day's end-of-day open interest.
~11% = ~73 questions. Heavy on order types, operating ranges, expiry mechanics, and pro account rules. 2-3 expiry date calculation numericals per exam. 3-4 questions on stop loss order trigger vs limit logic. Know trading hours and expiry time precisely.
Interest Rate Derivatives
Trading members, order types, price bands, SPAN, VaR and position limits
NISM Series IV — Interest Rate Derivatives | ~8% weightage | ~32 questions
Same structure as Series VIII CH6 and Series I CH6. Order types, trading members, price bands, position limits, quantity freeze. IRD-specific: price range for bonds/T-bills, minimum age 21 for trading member, SPAN margining applied client-by-client, and proprietary position netting at trading member level.
Trading Members (TMs): Members of the Exchange. Can EXECUTE trades only (not settle unless also a clearing member). Can trade for own account + clients.
Clearing Members: Members of Clearing Corporation. Can clear and settle trades.
Trading-cum-Clearing Member: Member of both Exchange and Clearing Corporation. Can execute AND settle trades including for other TMs.
Professional Clearing Member (PCM): Member of Clearing Corporation ONLY. Cannot execute trades. Can ONLY clear and settle trades of other TMs.
Key rule:
Minimum age for individual trading member: 21 years (per Securities Contracts (Regulation) Rules, 1957)
Limit price order: Buy at or below / Sell at or above specified price. Executes at favorable price.
Market order: No price specified. System determines price. Price-related condition.
Stop Loss order: Has a trigger price. Activated when market reaches trigger.
IOC (Immediate or Cancel): Execute immediately or cancel. Partial execution allowed.
Day order = Good Till Day (GTD): Valid for the day. Auto-cancelled at EOD if unexecuted.
Good Till Cancelled (GTC): Valid until cancelled.
Passive orders: Unmatched orders sitting in the order book. Active orders = incoming orders seeking to match.
Order priority: Best price first. Same price → earlier time priority. Buy = highest price first; Sell = lowest price first.
Definition: Maximum exposure levels for the entire market, trading member, and each client.
Position limits are set at:
Netting of positions:
Example from exam:
Price range = specified percentage above AND below base price
For exchange-traded IRDs:
Example: If SEBI says max 1%, exchange can set 0.5% but NOT 2%.
Overnight MIBOR futures: Operating range = ±5% of base rate
Quantity Freeze:
SPAN = Standard Portfolio Analysis of Risk
SPAN considers the entire portfolio of an investor for computing portfolio-wide margin requirements.
Applied between: Trading Members and their CLIENTS (not at CC-clearing member level)
Margins collected on: Client-by-client basis. Netting between clients NOT allowed for margin collection.
Contract-level minimum margin:
T-bill futures initial margin: VaR (99%, 1-day), minimum 0.10% on first day, 0.05% thereafter
G-Sec bond futures initial margin: VaR (99%, 1-day), minimum 2.8% on first day, 1.5% thereafter
90% collateral utilization = risk reduction mode When broker's collateral utilization hits 90%, all unexecuted orders are automatically cancelled.
Delivery versus Payment (DvP): Settlement method that eliminates settlement risk. Both parties simultaneously exchange cash and security — if one fails, other withholds.
Value at Risk (VaR): Maximum likely price change over a given horizon at a given confidence level.
Trap 1: "PCM can execute and settle trades" — FALSE PCM can ONLY settle trades of other TMs. Cannot execute any trades.
Trap 2: "Client positions can be netted across clients" — FALSE Client A long 12 + Client B short 10 must be reported separately as long 12 AND short 10.
Trap 3: "Quantity Freeze = maximum trade size limit" — FALSE Quantity Freeze is a check against erroneous entries. Not a hard limit. Orders above it just need explicit confirmation.
Trap 4: "Exchange can widen SEBI's price range" — FALSE Exchange can only TIGHTEN, not widen, the regulator's prescribed range.
Trap 5: "SPAN margin is applied between CC and clearing members" — FALSE SPAN is applied between TMs and their CLIENTS.
Trap 6: "T-bill and bond futures have same minimum margin" — FALSE Different: T-bills = 0.10%/0.05% | Bonds = 2.8%/1.5%
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