A Study of Indian Derivatives Market and its Current Position in Global Financial Derivatives Market

Derivatives emerged as hedging instruments out of the need to control price risk. Earlier commodity prices were the sole concern of business community, and therefore, the derivatives on commodities were the first ones to emerge. The introduction of derivatives in India can be traced out in 1875, when the Bombay Cotton Trading Association Ltd was set up for futures trading in cotton. At present the markets for derivatives have been growing at a phenomenal pace. This paper traces the growth and current position of Indian derivatives market. Since its inception in June 2000, derivatives market has exhibited exponential growth both in terms of volume and number of contract traded. The market turnover has grown from Rs.24bn in 2000-01 to Rs. 2376tn in 2018-19. The present study is an effort to demonstrate the growth and expansion of derivatives in India during the time period 201011 to 2018-19. It also encompasses the scope, history, concept, types and growth of financial derivatives in India and the status of Indian derivatives market vis-à-vis global derivative market.


Introduction
India's inclusion among the top economies of the world in recent years has helped the Indian stock market to reach heights than ever. People in India are therefore taking keen interest in investing stocks and other financial markets as well as various derivative instruments.
Derivative instruments are primarily used by individual as well as institutional investors in order to offset the substantial losses likely to be incurred by them. Derivative instrument is a type of contract whose value is derived from the price of the underlying asset and at the same time they remain distinctly independent from the underlying asset in all other aspects. This underlying asset is traded in the spot market or cash market. Hence there exist two markets for the same asset or commoditythe spot market and the derivative market. Many derivative contracts are offset or liquidated by another derivative before coming to the expiry of the term. This is exercised by the traders when the market goes against them and execution of the contract can cause loss to them.
Derivative trading though have well established market in the global scenario, have seen their presence in an organized from in Indian capital markets only since 2000. NSE was the first to introduce Derivative Segment in India by launching Index derivatives followed by derivatives on Individual stocks and on approved commodity. The latest inclusion of NSE is the commodity derivative in the year 2018 by introducing Bullion Futures. The oldest stock exchange of India BSE also conducts derivative trading. However, the Futures Industry Association (IFA) data shows that NSE has become the world's largest exchange by trading volumes, outpacing US-based CME Group. NSE notched up 6 billion contracts traded volume in 2019, surpassing the CME Group to become the world's largest exchange. In the light of the fact that more and more people are taking part in derivative trading like futures and options and are trading both in capital and commodity markets, there arises an imperative need for us to learn about every aspect of derivatives in detail.
The present study attempts to discuss the whereabouts of derivatives trading by tracing the historical development, types, trends, growth and developments of derivative market in India.

1.
To examine the performance of derivative market in India. 2. To understand the pattern of growth of derivative market in India. 3. To examine the current position of Indian derivative market in reference to global financial derivatives market.

Research Methodology
This is a secondary data based study. The data used for this research was obtained from academic journals, Google scholar search engines and various reports like Annual Derivatives Report of World Federation of Exchanges. Statistics regarding derivative market performance was compiled from the site of NSE.
The study is organized into five sections. First section deals with the concept, definition, uses and classification of derivatives. Second section has been devoted to a discussion of evolution and growth of derivatives market in India. Thirdly a discussion on the statistical information (data) collected from secondary sources has been given. Later on the paper discusses the status of Indian derivative market in the global derivative market. The last section specifies summary and concluding remarks of the study along with some findings derived from the study.

Limitations of the Study
 The findings drawn from the study may hold good only for the year of study as the data may change over period.  Due to the time constraint, study has not able to cover up every aspects of derivative market in detail.

Concept of Financial Derivatives
Derivatives have been in use for a long time but they still remain a mystery for a vast majority. The commodity derivatives were the earliest entry in the market. Afterwards, in the 1970s derivatives were introduced gradually on a number of underlying assets. These were instruments used by corporations to reduce their exposure to various kinds of risks.
A derivative is a financial product which has derived its value from another financial product or commodity. Thus the derivatives do not have independent existence without underlying product and market. Derivatives are contracts which are written between two parties for easily marketable assets. They are also known as deferred delivery or deferred payment instruments. The exchange traded derivatives are quite liquid and bear low transaction cost. It is also possible to combine them to match specific requirements. In other words, they are easily amenable to financial engineering. Definition: The securities contracts (Regulation) Act 1956 defines "derivative" as under section 2 (ac). As per this "Derivative" includes (a) "a security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security." (b) "A contract which derived its value from the price, or index of prices at underlying securities." As such the financial derivatives are financial instrument whose prices or values are derived from the prices of other underlying financial instruments or financial assets. The underlying instruments may be an equity share, stock, bond, debenture, Treasury bill, foreign currency or even another derivative asset.
Uses of Derivatives:  To control, shift, avoid, reduce, eliminate or manage efficiently various types of risks through hedging, arbitraging, and insuring against them.  They serve as barometers of future trends in prices which would in turn result in the correction of prices on the spot market.  Derivative products enhance liquidity and reduce transaction costs in the market for the underlying assets.  They enable individual investors as well as institutional investors to design strategies for proper asset allocation and portfolio management.  Derivative market narrow down price spread and integrates price structure at different points of time.
 It facilitates the process of diversification.  Encourage competition

Classification of Derivatives:
There are various types of financial derivatives based on their different properties like, plain. Simple or straight forward, composite, joint or hybrid, synthetic, leveraged, mildly leveraged, customized or OTC traded, standardized or organized exchange traded, regulated and unregulated etc. are available in the market.
There are many ways in which the derivatives can be categorized based on the markets where they trade; based on the underlying asset and based on the product feature etc. some ways of classification are following: A. Financial and Non-financial derivatives a) Financial derivatives are derivatives which are of financial nature. They are following: i. Forwards ii. Futures iii. Options iv. Swaps b) Non-financial derivatives Those derivatives which are not of financial nature are called non-financial derivatives. They are following: i. Commodities ii. Metals iii. Weather iv. Others

B. On the basis of market where they trade
On the basis of this classification, the derivatives can be classified into three categories namely; OTC traded derivatives and exchange-traded derivatives. a) OTC traded derivatives: These are the derivative contracts which are traded directly between two parties, without going through an exchange or other intermediary. The OTC derivative market is the largest market for derivatives and largely unregulated with respect to disclosure of information between parties.
They are the following: i. Swaps ii. Forward rate agreements iii. Exotic options iv. Other exotic derivative b) Exchange-traded derivatives: These are derivative instruments that are traded via specialized derivatives exchange or other exchanges. A derivatives exchange is a market where individuals' trade standardized contracts that have been defined by the exchange. Derivative exchange act as an intermediary to all related transactions and takes initial margin from both sides of the trade to act as a guarantee. They may be the following: i. Futures ii. Options iii. Interest rate iv. Index product v. Convertible

1) Forward contract
A forward contract is an agreement is entered into between the buyer and seller in order to day to exchange the commodity or instrument for cash at a predetermined future date at a price agreed upon today. Such predetermined price is called 'forward price'.

2) Futures contract
The futures contracts are almost similar to forward contracts, but differing in some characteristics. Futures contracts are otherwise known exchange traded forwards. In other words, futures contracts are standardized, exchanges traded and are subject to rules and regulations of the exchange. The quantity and grade of commodity in each contract is also predetermined.

3) Options contract
An option is a particular type of a contract between two parties where one person gives the other person the right to buy or sell a specific asset at a specified price within a specified time period. In theory, option can be written on almost any type of underlying security. Equity (stock) is the most common, but there are also several types of non-equity options, based on securities such as bonds, foreign currency, indices or commodities such as gold or oil.

4) Swaps contract
Swap is an agreement between two or more parties to exchange a stream of future cash flow with another stream of cash flow with different characteristics. Swaps are useful in avoiding the problems of unfavorable fluctuation in FOREX market. The parties that agree to the swap are known as counter parties. The two commonly used swaps are interest rate swaps and currency swaps.  Table 1 shows the chronological development of Indian derivative market.   The pattern of performance of Stock Options is such that there were some fluctuations in the turnover in the period 2010 to 2013. Afterwards it is showing very unpredictable rise for the next two years. Then again there was deep fall in the year 2016. But the market was able to recover itself in the next year itself. However, similar to stock futures, stock option trading is also depicting a downfall during the previous year. The trading performance of Index Options is doing extremely well in the past 10 years. It is only derivative product which is having such strong and steady rise in the turnover. In the recent years the only downfall in the turnover was in 2015 that too very minor one.   Thus, it is evident from the statistics compiled from NSE, regarding the derivatives that the major portion of the derivative market accounts for Index Options. Only 5%, 4% and 2% constitute stock futures, Stock Options and Index Futures. As of now Index Futures are the least developed segment of the Indian Derivative Market.

Evolution of Derivative Market in India
In the case of Currency Future there has been a high degree of fluctuation in the volume of trading in every alternative year starting from 2014 onwards. The size of variation is also huge. But in the case of Currency Options, apart from the slight downfall in the period ranging from 2013 to 2015, there has always been a rising trend. However, the previous year was no better for Currency Options as well.

Status of Indian Derivative Market in the Global Derivative Market
The World Federation of Exchanges presents an annual report which reveals the current status of global derivatives market. The report is prepared based on a survey of derivatives market. The members of WFE, its affiliates and other renowned exchanges voluntarily submit their data to this survey. The report is named as WFE IOMA Derivatives Report. This provides a detailed analysis of separate derivatives instruments along with their volume of trading, turnover and other important details. The latest report published by World Federation of Exchange was on 10th April 2019.

A. Analyses of India's Position in the Global Derivative Market
Here, in this study, in order to understand the present status of derivative market of India with regard to global derivatives market, the position of Derivative Market of India for the last four years, in respect to the trading volume of different derivative products has been compiled from the various editions of the WFE IOMA Derivative Reports. Derivative Market of India comprises of renowned exchanges like National Stock Exchange, Bombay Stock Exchange Limited as well as Multi Commodity Exchange of India. Here, the statistics shows that India was able to maintain a more or less steady market for the Stock Futures. In fact, the trading volume has been increasing from year to year with a high margin.  The data regarding Stock Option trading depicts that India was able to maintain a strong and steady position in the Stock Options trading. The margin of trading volume is very high in the previous year as compared to past years.  far not able to place any of its Derivative Markets in the list of top 10 exchanges. 9) In the global financial market, with regard to Currency futures and options India has been able to acquire topmost positions by the major exchanges of NSE and BSE. 10) Multi Commodity Exchange of India is having 8th position in the ranking of world exchanges in respect to commodity futures and options contracts traded in the year 2018-19.

Suggestions
 Derivative market is considered highly volatile as compared to other segments of the capital market. Better control mechanism if introduced, can bring about stability in the market performance.  Every aspect of derivative market other than Index Options and Commodity futures is showing a downward trend during 2019-20. This may be due to the sudden policies and reforms introduced by the government. Therefore, the government shall focus at bringing more stability in their policies and reforms so as to have stable economic condition in the country.  Participation of international investment agencies should be streamlined so that the impact of global market crisis could be better managed and controlled.

Summary and Conclusion
Derivatives act like double-edged sword. On the one hand, derivatives if used effectively provides many benefit to the society like dissemination of information and bringing out liquidity and helping out in diversification as well as portfolio management. On the other hand, when used with in discretion, they may cause unimaginable miseries. Therefore, with the increased trading in derivatives, it is opined that there should be proper and well established regulatory system in order to check the misuses. Most of the derivative transaction does not keep proper accounting records which make the audit of such transactions a difficult task. Derivative transaction with proper disclosures and control can act as a catalyst in the growth of Indian economy. The government shall introduce efficient regulatory system specifically meant for derivative market which shall be investors friendly as well.