Are you planning to trade in the derivatives market? Hoping to know how it can help you enjoy more profits? Let’s read about what derivatives are and how to trade them.
Derivatives are described as financial contracts whose value is decided from underlying assets. The underlying assets here could be currencies, stocks, products, commodities, rates of exchange, or interest rates. In the last couple of years, there has been significant growth in the derivatives market with the launch of numerous derivative contracts worldwide. The main reason for the sudden surge in derivatives market is higher fluctuations in asset rates, deployment of financial markets across the world, better awareness about this market among the participants, etc.
In this write-up, we will discuss the requirement to trade in the derivatives market. We will also discuss the possible options and future of this kind of trading.
A Brilliant Example of a Derivatives Market?
Suppose a rice farmer wants to sell 20 quintals of rice after six months at Rs. 3000/quintal. However, he doesn’t want to take risks and thus decides to get in touch with a broker. The seller agrees to sell 10 Quintal rice after six months at Rs. 3000. In case, the next day the cost reduces to Rs. 2900 due to some expected reasons, the broker has to legally pay Rs. 3000 as committed to the farmer. However, after six months, if the rate of rice increases to Rs. 3100, the farmer would lose Rs. 100/quintal as the farmer is legally bound to sell it for Rs. 3000/ as per the contract with the broker.
This is how the derivative market works.
There are four main kinds of derivative contracts including:
Forwards & Futures
Under these financial agreements, buyers are obligated to buy an asset at a cost decided in advance on a mentioned future date. These kinds of derivatives are tailored contracts and can’t be traded anywhere.
Under this kind of derivative, the buyers are obligated to buy an asset at a mutually decided cost. Here the kind of forwards & futures contracts are identical. However, the main difference between the two is that futures are mostly traded on the Exchanges.
Options give the buyer ownership but not the obligation to either buy or sell the asset at a mutually decided price. There are 2 kinds of options including call and put option.
In the former one, one has the right but no obligation to purchase a fixed quantity of an underlying asset at a particular cost. However, in the latter one owns the right but no obligation for selling an underlying asset at a particular price. To purchase any of the options, paying a premium amount is mandatory.
These allow cash flow exchange between 2 parties. The most common kinds of swaps in the trading market include currency swaps, Interest rate swaps, and commodity swaps.
Prerequisites for Derivatives trading
Toconduct your trades, you need to create an online trading account. The account number acts as the identity to trade in the markets. Make sure that your account allows you to trade in derivatives and in case there is some issue, you can get in touch with yourexpertsto get the services activated.
To trade derivatives in the country’s stock market, one has to link his/her DEMAT account with their trading account.
Arrange the mandatory margin amount
One can enter into derivatives contracts by paying just a small amount and requires an extra margin in traders’ hands according to the stock fluctuation. There will be a change in the amount due to a change in the underlying stock. So, it is recommended to keep additional money in the account.
Since the derivative has high risk attached to them, thus the derivative trader needs to keep some amount of the value as cash. The same amount is known as margin money. The Securities and Exchange Board of India (SEBI) regulates the trading of derivatives in the nation’s stock market. SEBI has fixed certain margin limits to lower the risk involved for the stock exchanges a person is trading on.
Important Things to Note Down in Derivatives Market
This is the most important factor which needs to be considered before foraying into the derivatives market. All the details will be available in Derivatives contracts, so make sure you go through them carefully.
Another important thing is margin maintenance. Choose the stocks and their contracts based on the amount you have, the margin requirements, underlying shares’ cost, and contract cost.
Hope now you know what the derivatives market is and how to trade in the market. Derivative trading is considered a high-risk and high-profit market and to foray into the derivatives in the Indian stock market, it is mandatory to have a trading account.
If you are a fresher and beginning with trading for the first time, it is suggested to take the help of the experts. They can guide you more on the derivatives market and can let you know the options and future of this kind of trading. Taking the help of professionals makes trading easier and more profitable.