Types of Underlying Assets in Indian Share Market Derivatives

The Indian derivatives market has grown exponentially over the last few decades, thanks to its role in managing risk and optimizing trading strategies. Derivatives are financial contracts whose value is derived from an underlying asset. In the Indian share market, understanding the types of underlying assets is crucial for effective risk management, hedging, and speculation. In this blog, we will discuss various underlying assets in derivatives, their significance, and how they contribute to the overall derivatives market.

Introduction to Derivatives and Underlying Assets
Types of Underlying Assets in the Indian Derivatives Market
- Stocks as Underlying Assets
- Indices as Underlying Assets
- Commodities as Underlying Assets
- Interest Rates as Underlying Assets
- Currency or Forex as Underlying Assets
Historical Data on Underlying Assets
Significance of Each Type of Underlying Asset
How Underlying Assets Affect Derivatives Pricing
Using Historical Trends for Trading Strategies
Popular Derivatives Contracts in India
Conclusion

1. Introduction to Derivatives and Underlying Assets

Derivatives are contracts that derive their value from an underlying financial asset or group of assets. These assets can range from stocks, bonds, commodities, currencies, indices, and interest rates. In the Indian share market, the most actively traded derivatives are options and futures contracts. The selection of an underlying asset is critical as it determines the derivative’s performance and price movement.

2. Types of Underlying Assets in the Indian Derivatives Market

The Indian share market offers a variety of underlying assets for derivatives trading. Each asset type plays a distinct role in how derivatives are priced and traded. Let’s dive deeper into the most common types:

a. Stocks as Underlying Assets

Individual stocks or shares are the most common form of underlying assets for derivatives in India. Derivatives like stock futures and options derive their value from the price of individual stocks. Some of the most traded stocks in the Indian derivatives market include Reliance Industries, Infosys, and HDFC Bank.

Historical Data: Stock-Based Derivatives Trading Volumes (2019-2023)

Year	Stock-Based Derivative Contracts (in million)
2019	1450
2020	1620
2021	1785
2022	1950
2023	2100

b. Indices as Underlying Assets

Indices, such as NIFTY 50 and Bank NIFTY, are also commonly used as underlying assets. Index-based derivatives help traders take positions on the overall market rather than individual stocks. The NIFTY options market, in particular, sees huge trading volumes, making it a key component of India’s derivatives landscape.

Historical Data: Index-Based Derivatives Volumes (2019-2023)

Year	NIFTY Index Derivatives (in million)
2019	980
2020	1220
2021	1480
2022	1650
2023	1825

c. Commodities as Underlying Assets

Commodities such as gold, crude oil, and agricultural products are popular underlying assets in derivatives trading. The Multi Commodity Exchange of India (MCX) is the key platform for commodity derivatives in India. Commodities can offer great opportunities for hedging against inflation and volatility.

Historical Data: Commodity-Based Derivatives (Gold Futures) (2019-2023)

Year	Gold Futures Contracts (in million)
2019	650
2020	720
2021	810
2022	900
2023	960

d. Interest Rates as Underlying Assets

Interest rate derivatives allow traders to hedge or speculate on future interest rate movements. In India, interest rate futures and swaps are popular for managing risks related to changing rates. The pricing of these derivatives is influenced by benchmark interest rates such as the repo rate set by the Reserve Bank of India (RBI).

e. Currency or Forex as Underlying Assets

Currency or forex derivatives allow traders to take positions on the price movements of currency pairs. The Indian Rupee (INR) against the US Dollar (USD) is the most actively traded pair in the Indian forex derivatives market. The market is influenced by global currency trends, trade policies, and interest rate differentials between countries.

3. Historical Data on Underlying Assets

Historical Data: Growth in Derivatives Market (2019-2023)

Year	Total Derivatives Contracts (in million)
2019	2800
2020	3200
2021	3700
2022	4250
2023	4700

This growth is driven by increased participation in stock, index, and commodity derivatives in the Indian market, coupled with greater demand for hedging instruments.

4. Significance of Each Type of Underlying Asset

Each type of underlying asset brings unique advantages to traders and investors. Stocks allow traders to focus on specific companies, while indices offer a broader market perspective. Commodities, interest rates, and currencies enable diversification and hedge against sector-specific risks. Advanced traders use a combination of these assets to balance their portfolios and manage risks effectively.

5. How Underlying Assets Affect Derivatives Pricing

The pricing of derivatives is heavily dependent on the nature of the underlying asset. Stock and index derivatives are influenced by market conditions, earnings reports, and macroeconomic factors. For commodities, pricing is influenced by supply and demand dynamics, geopolitical events, and seasonal trends.

For example, the price of crude oil derivatives may spike due to geopolitical tensions in oil-producing regions. Similarly, currency derivatives can experience volatility based on central bank announcements and foreign trade policies.

6. Using Historical Trends for Trading Strategies

Advanced traders often use historical data to predict future trends in underlying assets. By analyzing past volatility, market performance, and macroeconomic events, traders can develop strategies to hedge or speculate in the derivatives market.

Table: Historical Volatility Data (2019-2023)

Year	NIFTY 50 Volatility (%)	Gold Volatility (%)
2019	12.50	18.40
2020	24.80	22.10
2021	16.00	15.60
2022	19.50	17.20
2023	14.30	13.90

7. Popular Derivatives Contracts in India

Several derivatives contracts have become highly popular in India, including:

NIFTY 50 Index Options: These are widely traded and offer high liquidity.
Stock Futures: Traders use stock futures to speculate on the price movement of individual stocks.
Gold Futures: Highly popular on the MCX, gold futures are used to hedge against inflation and currency devaluation.

Each of these contracts is based on different types of underlying assets, which allow for flexible trading strategies.

8. Conclusion

The Indian share market derivatives segment is vast and includes a variety of underlying assets such as stocks, indices, commodities, interest rates, and currencies. Understanding these different types of assets is crucial for any trader or investor seeking to make informed decisions in the derivatives market. By analyzing historical data and market trends, traders can develop effective strategies to capitalize on the dynamic nature of the derivatives market.