INDEX DERIVATIVES
Index derivatives are derivative contracts which derive their value from an underlying index. The two most popular index derivatives are index futures and index options. Index derivatives have become very popular worldwide. Index derivatives offer various advantages and hence have become popular.
Institutional and large equity holders need portfolio hedging facility. Index derivatives are more suited to them and more cost effective than derivatives based on individual stocks. Pension funds in the US are known to use stock index futures for risk hedging purposes.
Index derivatives offer ease of use for hedging any portfolio irrespective of its composition.
Stock index is difficult to manipulate as compared to individual stock prices, more particularly in India, and
the possibility of cornering is reduced. This is partly because an individual stock has a limited supply, which can be cornered.
Stock index, being an average, is much less volatile than individual stock prices. This implies much lower capital adequacy and margin requirements.
Index derivatives are cash settled, and hence do not suffer from settlement delays and problems related to bad delivery, forged/fake certificates.
