NISM Series XII · Unit 6 of 7 · about 10% of the paper
Derivatives markets: NISM Series XII notes and practice questions
Futures and options in simple terms: what they are, why people use them and the key vocabulary.
What to know in Unit 6
- Futures versus options.
- Hedging, speculation, arbitrage.
- Lot size, margin and expiry.
Key terms, examples and exam traps
Derivative
A derivative is a contract whose value is derived from an underlying asset such as a share, index, currency or commodity.
Example. A contract whose value depends on the price of the Nifty 50.
Exam trap. This statement is false: A derivative has its own value, independent of any underlying.
Futures contract
A futures contract is an agreement to buy or sell an underlying at a fixed price on a future date, traded on an exchange with standard terms.
Example. A trader agrees today to buy an index lot at a set price at month-end.
Exam trap. This statement is false: A futures contract is an option with no obligation.
Option contract
An option gives the buyer the right, but not the obligation, to buy or sell the underlying at a fixed price on or before expiry, in return for a premium.
Example. An investor pays a fee to keep the right to buy a share at ₹100.
Exam trap. This statement is false: An option obliges the buyer to complete the trade.
Call option
A call option gives its buyer the right to buy the underlying at the strike price.
Example. An investor expects prices to rise and buys the right to buy at ₹500.
Exam trap. This statement is false: A call option gives the right to sell.
Put option
A put option gives its buyer the right to sell the underlying at the strike price, and is used for protection or for gains when prices fall.
Example. An investor holding a share buys the right to sell it at ₹90.
Exam trap. This statement is false: A put option gives the right to buy.
Strike price
The strike price is the fixed price at which the option holder can buy or sell the underlying.
Example. An option allows the holder to buy at ₹2,500.
Exam trap. This statement is false: The strike price is the premium paid.
Premium
The premium is the price paid by the option buyer to the seller for the right granted.
Example. The buyer pays ₹20 per unit for an option.
Exam trap. This statement is false: The premium is returned to the buyer at expiry.
Hedging
Hedging uses derivatives to reduce the risk of adverse price moves in an existing position.
Example. A shareholder takes a position that offsets a possible fall in his holdings.
Exam trap. This statement is false: Hedging is aimed at maximising speculative profit.
Speculation
Speculation is taking a view on price direction and positions to profit from it, accepting the risk of loss.
Example. A trader buys index futures expecting a rise over the next week.
Exam trap. This statement is false: Speculation is risk-free.
Arbitrage
Arbitrage involves buying and selling related instruments at the same time to profit from price differences, with little risk.
Example. A trader buys a share in the cash market and sells its future at a higher price.
Exam trap. This statement is false: Arbitrage is a bet on market direction.
Lot size
The lot size is the fixed number of units in one derivatives contract, set by the exchange. Trading is in multiples of lots.
Example. An index future trades in minimum quantities of 75 units.
Exam trap. This statement is false: Investors can trade any number of units in a futures contract.
Expiry
Expiry is the date on which a derivatives contract ceases to exist and is settled.
Example. An options contract expires on a date fixed by the exchange.
Exam trap. This statement is false: Derivative contracts have no end date.
Margin in derivatives
Margin is the money a trader deposits with the broker as security for performing a futures or option-selling obligation.
Example. A futures trader deposits a fraction of the contract value as security.
Exam trap. This statement is false: Margin is the full contract value.
Mark-to-market
Mark-to-market is the daily adjustment of futures positions to the day's settlement price, with gains and losses settled in cash.
Example. A futures trader's account is credited or debited at the end of every day.
Exam trap. This statement is false: Mark-to-market happens only at expiry.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which statement best describes “Strike price”?
- A credit rating is an independent agency's opinion on the issuer's ability to repay debt on time. Higher ratings mean lower risk.
- The DRHP is the draft offer document filed with SEBI for observations before an IPO, without final price details.
- Market capitalisation equals the share price multiplied by the number of shares outstanding, and shows the market value of a company's equity.
- The strike price is the fixed price at which the option holder can buy or sell the underlying.
Q2. Which statement best describes “Premium”?
- Commercial paper is an unsecured, short-term money-market instrument issued by companies at a discount to meet working-capital needs.
- Participants include issuers, investors, brokers, depositories, clearing corporations, merchant bankers, mutual funds and regulators.
- The premium is the price paid by the option buyer to the seller for the right granted.
- Insider trading is dealing in securities based on unpublished price-sensitive information, and it is prohibited by SEBI.
Q3. Which statement best describes “Arbitrage”?
- Promises of guaranteed returns, pressure to invest quickly and unregistered advisers are warning signs of fraud.
- Arbitrage involves buying and selling related instruments at the same time to profit from price differences, with little risk.
- An option gives the buyer the right, but not the obligation, to buy or sell the underlying at a fixed price on or before expiry, in return for a premium.
- SME platforms on exchanges allow small and medium enterprises to list with simpler rules but with larger minimum application sizes and higher risk.
Q4. Which term is described here? Hedging uses derivatives to reduce the risk of adverse price moves in an existing position.
- Past performance
- Exit load
- Hedging
- Riskometer
Q5. Which term is described here? A call option gives its buyer the right to buy the underlying at the strike price.
- Exit load
- Margin trading
- Market performance indicators
- Call option
Q6. Which term is described here? Speculation is taking a view on price direction and positions to profit from it, accepting the risk of loss.
- Speculation
- Retail individual investor
- Strike price
- Securities market
Frequently asked questions
How much of NISM Series XII comes from Unit 6?
Unit 6 (Derivatives markets) usually carries about 10% of the questions. The whole exam has 100 questions and the pass mark is 60%.
What should I study in NISM Series XII Unit 6?
Futures versus options. Hedging, speculation, arbitrage. Lot size, margin and expiry.
Are these NISM Series XII practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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