Trading & Capital Markets · Chapter 5 of 8
Cash, futures and options — what each is actually for
Not the payoff diagrams. What each instrument is used for, what it costs to hold, and the specific ways each one surprises people.
You can find payoff diagrams anywhere. What interviews actually probe is whether you understand what a professional uses each instrument for, and what the non-obvious costs are — because those are what separate someone who has traded from someone who has read.
Cash equity
You own the thing. Two costs that people under-weight: the capital is fully committed, and in India, STT on delivery is charged on both legs, which makes high-frequency delivery-based strategies structurally unattractive. Corporate actions accrue to you — dividends, bonuses, rights — which sounds like a benefit and is a real operational burden if you hold at scale.
Futures
An obligation to transact at a fixed price on a fixed date. The professional uses are hedging and expressing a directional view with capital efficiency; the retail use is leverage, which is the same thing with worse risk management.
- Margin, not premium. You post initial margin and settle mark-to-market in cash daily. The daily settlement is the part people miss: a loss is money leaving your account today, not a paper number. A position that would have been profitable at expiry can still bankrupt you in week two.
- Basis. The futures price is not the spot price. It reflects cost of carry — interest, less dividends. In India the index futures basis is a real and tradable quantity, and the roll cost between expiries is a genuine drag on anyone holding a directional position across months.
- Physical delivery on Indian single-stock derivatives. Stock futures and options settle by physical delivery at expiry. An in-the-money stock option held to expiry creates a delivery obligation with a full-value margin requirement in the days before — which has caught a very large number of retail traders who thought they held a cheap option and discovered they held a large equity obligation.
- Index futures are cash settled, which is why they behave completely differently at expiry.
Options, and the four things that actually matter
An option is the right, not the obligation, to transact. The useful mental model is not the payoff diagram; it is that you are trading volatility and time, and direction is only one of several exposures you have taken on.
| Greek | What it measures | What it means practically |
|---|---|---|
| Delta | Sensitivity to the underlying | Your directional exposure. It changes as the price moves, which is the whole difficulty |
| Gamma | How fast delta changes | Short gamma means your position gets worse in both directions as it moves. Near expiry it becomes enormous — this is why expiry-day risk is qualitatively different |
| Theta | Time decay per day | The seller's income and the buyer's rent. Accelerates sharply in the final days |
| Vega | Sensitivity to implied volatility | You can be right on direction and lose money because volatility collapsed. This is the most common way a first options trade goes wrong |
Implied volatility is a price, not a forecast
Implied volatility is simply the number you put into the pricing model to recover the price the market is actually trading at. It is quoted as volatility because that is a more comparable unit than rupees of premium — not because anyone is predicting it.
The practically useful consequence: implied volatility is systematically higher than the volatility that subsequently realises, across markets and across decades. That gap is the volatility risk premium, and it is compensation for taking on the risk of a large move, not free money.
The trap is concluding that selling options therefore has an edge. The premium is real; capturing it requires delta-hedging the directional exposure, and the hedging costs consume a large share of it. A naked short straddle does not harvest the volatility risk premium — it takes a large directional bet that happens to be profitable most of the time and catastrophic occasionally. Saying that clearly in an interview is a very strong signal.
The Indian options market specifically
Index options dominate Indian derivatives volume, and short-dated contracts dominate index options. That produces a market with distinctive properties worth being able to describe:
- Extremely cheap options on expiry day, which look like lottery tickets and price like them. Most expire worthless; the distribution of outcomes is heavily skewed.
- Enormous gamma near the money in the final hours, which means dealer hedging activity is concentrated and can amplify intraday index moves.
- Premium is now collected upfront from option buyers under the SEBI changes, and margin near expiry was increased — both directly aimed at this segment.
- SEBI's own published research found the large majority of individual traders in equity F&O lost money over the studied periods. Whatever your view of the policy response, the data is the regulator's and it is the reference point in any Indian conversation about this market.
Commodities and currency, briefly
MCX commodities track international benchmarks, which is why the session runs until late evening IST — the price is being made in London and New York, and the Indian contract has to stay aligned. Crude and natural gas are the liquid contracts; gold and silver have mini variants that make position sizing accessible. Gaps between the previous close and the next open are larger than in equities because the underlying trades while MCX is shut.
Currency derivatives are jointly regulated by SEBI and RBI, and the eligibility rules for taking positions without an underlying exposure have been tightened. This is a segment where the regulatory constraint is a bigger factor in strategy design than the market structure is.
Check yourself