Introduction to Financial Derivatives for Hedging. How Retail Investors Can Use Hedging in Their Por

. What Are Financial Derivatives? Imagine you’re planning a wedding six months from now. You want to book a photographer today for ₹50,000. But what if prices go up in six months? To avoid that, you ask the photographer to sign a contract now, locking in the price. That’s your insurance against price hikes. That contract? That’s a derivative—because it derives its value from an underlying service (photography in this case). In financial markets, derivatives are contracts whose value is tied to assets like: • Stocks • Bonds • Commodities (gold, oil, wheat) • Market indexes (Nifty, Sensex) • Currencies (USD, INR) • Interest rates 2. Why Hedging Matters in Today’s Market Investing is like sailing—you need to move forward, but you also need to protect your boat from the waves. Those “waves” could be: • A sudden drop in the stock market • Interest rate hikes • Currency fluctuations • Company-specific bad news If you’ve ever felt nervous watching your investments drop during a market dip, hedging is your safety net. It helps you soften the blow when the market goes against you. Think of it like wearing a helmet when you ride a bike. It doesn’t help you ride faster—but it protects you in a crash. 3. Types of Financial Derivatives The main types of derivatives that retail investors might encounter. A. Futures Contracts A futures contract is an agreement to buy or sell something at a specific price at a future date. Example: You agree today to buy 100 grams of gold at ₹6,000/gram one month from now. Even if the market price becomes ₹6,500/gram, you still pay ₹6,000. Win for you Futures are mostly used for commodities and indexes. In India, Nifty Futures and Bank Nifty Futures are popular among retail investors. B. Options Contracts Options give you a choice—not a compulsion. • Call Option: Right to buy at a set price • Put Option: Right to sell at a set price Example: You buy a put option for your Reliance shares at ₹2,400. If the stock crashes to ₹2,200, you can still sell at ₹2,400. That’s protection C. Forwards and Swaps These are mostly used by large corporations and banks, especially for hedging currencies or interest rates. Less relevant for retail investors but worth knowing they exist. 4. The Art of Hedging – What It Is and What It Isn’t Let’s clear up a big myth: Hedging is not speculation. You’re not trying to get rich quick. You’re trying to protect what you already have. example: You own ₹10 lakh worth of stocks. The market feels uncertain. You buy a few put options to protect the downside. If the market crashes, your portfolio drops—but the puts gain in value. That helps balance the loss. So instead of reacting emotionally (like panic-selling), you stay calm and stay invested. 5. Hedging Strategies That Retail Investors Can Use A. The Protective Put – “Portfolio Insurance” Own a stock you love, but scared it might fall short term? Buy a put option. Example: You own TCS at ₹3,800. You buy a put at ₹3,600. If TCS falls to ₹3,400, you can sti