1. Equity as the Foundation
Equities (cash market) are the base of the financial market. They represent ownership in companies and have intrinsic value determined by fundamentals such as earnings, growth prospects, and demand-supply balance. By design, derivatives (futures & options) are contracts derived from equities, so settlement and valuation models are anchored in spot prices.
- Spot market reflects real ownership and delivery.
- Futures & options take value from the spot using cost of carry and option pricing models.
- Settlement dependency ensures derivatives cannot detach from equity for long.
2. Derivatives as the Amplifier
While equities provide the anchor, derivatives act as a powerful amplifier in the short term. The F&O segment trades at much higher volumes and provides leverage that attracts large players, making it easier for them to shape short-term moves.
- High liquidity in derivatives makes them the main speculation zone.
- Leverage effect allows control of large market exposure with limited capital.
- Index heavyweights can be moved to align spot with derivative targets.
3. Equity → Derivatives (Long-Term Control)
In the long run, the equity market is the driver. Fundamental shifts in companies, institutional flows, or macroeconomic events directly affect stock prices, and derivatives automatically reprice to stay aligned.
- Strong earnings → Stock rises → Futures & Calls gain.
- Weak results → Stock falls → Futures & Puts gain.
- Over time, derivatives always adjust to equity’s reality.
📌 Anchor Principle: Equity controls derivatives because settlement is always against spot.
4. Derivatives → Equity (Short-Term Control)
In the short term, derivatives can strongly influence equities. Large players often build futures or options positions first and then use selective cash trades to push spot toward their levels, especially near expiry.
- Expiry pinning occurs when spot hovers near option strikes with highest open interest.
- Short-term manipulation is possible due to concentrated bets in derivatives.
- Market psychology makes traders follow OI and IV data more than delivery volumes.
📌 Leverage Principle: Derivatives dominate short term because of leverage and mass participation.
5. Feedback Loop of Control
The market functions as a two-way system. Equities remain the anchor for true value, but derivatives dominate short-term price movements. Neither can fully separate from the other, creating a cycle of push and pull.
- Intraday & Expiry → Derivatives dominate moves.
- Medium to Long Term → Equities dominate with fundamentals.
- Overall Reality → A feedback loop where one sets the base, the other magnifies.
🔀 Final Theory in Simple Words
- Equity = Foundation of value (long-term anchor).
- Derivatives = Amplifier of moves (short-term driver).
- Market is a feedback loop: equities create the base, derivatives exaggerate but must settle back to equity.