Can there be any progress in life – whether individual or collective – without taking risk inherent in the path of progress? There is an old saying that no risk can be more ruinous than taking "NO RISK".

The above fact is applicable in all market situations – whether commodity market or bullion market, precious metal market or foreign currency market or interest market both foreign or domestic or debt market etc.

This risk element is most conspicuous on capital markets. The single aspect that can be said with high level of certainty regarding capital market is the uncertainty of the market due to volatility. The market may scale near heights in minutes and at the same time may touch the trough in the next few minutes. Who can forget "black" 6^th October 1987 ? Over exposure to risk washed out 125 years old Bank of Baring.

As human beings are always adventurous in thoughts/ideas, the financial market analysists started to think how to hedge the risk. It was also for consideration what should be the tool to hedge the risk.

Of late we have been hearing much about "Derivatives", "Future", "Option" etc. pertaining to capital – that too in respect of equity segment.

If we look at our equity market we will observe one very interesting feature is that prices of highly traded shares are determined on the basis of instant mood/sentiment – what is happening now – ignoring what may happen next week or next month or so. In short, today’s prevailing price has no relevance to price structure which may arise after a month or so. In a dynamic market situation, linkage of the prevailing situation with future cannot be ignored. A jute mill owner signing an export contract for delivery of jute products after 3 months at pre-determined price will have to link present price of raw jute with possible price in coming months. Similarly the fund manager of a financial institution – domestic or foreign – or fund manager of mutual fund invested substantial fund in securities of ABC & Co. By availing of best possible analytical tools the above fund managers are not sure if they will have the expected price for these shares of ABC & Co. The price may decline leading to substantial loss. In the above situation, can we think of some sort of "insurance cover" to avoid the loss or at least to reduce the loss ?

In order to contain the risks indicated above, various types of products viz. Index future, options etc. have been innovated. In India, NSE & BSE, two major Exchanges started recently trading in index futures as derivative products.

We all know there are various indexes in capital market like Sensex, NSE-fifty, Nasdeq-100, Nikkie-225. The need of the index is to capture the movement of prices in stock market. So it is just a number representing changes in a set of values between two time period. It is thus obvious that change in the value of Index is determined by changes in value of some underlying assets which in the instant case are the value of shares. Hence it is known as derivatives – deriving values from underlying assets.

What is the implication of the word "future". Actually it is a contract between two parties to buy & sell a specified index for a specified period (say 1,2,3 months) at a specified price. On the expiry date of the contract the parties will settle the contract. On the expiry day, the contract may be settled by parties different from the original ones. Because the contract is tradeable, it may have gone through several rounds of sale purchase. What does it mean ? You always have several contracts floating in the market with different expiry dates. You may pick up one to suit your needs for hedging the risk.

Let us explain in simple terms how it happens. Suppose an operator of the market feels that shares of ABC & Co. are over-valued and prices will decline. He decided to sell ABC. Despite it, the broad market movement may be such that his loss increased. What is the safety valve he had at that moment ? He could have found a lot of future contracts with different dates of expiration. He could have found a lot of future contracts with different dates of expiration. He could have coupled his "sell ABC" with "buy sensex". The above combination may not only reduce his loss – may even completely wipe out the loss due to decline in the price of a specific stock namely ABC & Co. in this case.