Everything You Need to Know About Derivatives

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Derivatives are a class of instruments that have held the investor’s interest over the years. This is a security with a price that depends on one or more underlying assets; they have no independent value. The value is determined by the fluctuations in the underlying asset. The underlying assets could be currencies, bonds, interest rates, market indexes, and commodities. So, whether you are a long-term investor or a short-term speculator, derivatives market is the best place for you. Therefore, before trading in derivatives, we need to understand them carefully and make the best use of them:

Types of Derivatives:

  1. Futures: Futures are contracts that represent an agreement to buy or sell a set of assets at a pre-defined time and price. In case of futures, conditions are standardized, such as price, quantity and time.
  2. Forward: The owner has the obligation to sell or buy a contract at a pre-defined time. Forwards are basically futures, which are not standardized.
  3. Option: These contracts are very much similar to futures and forwards. The owner has the option to buy or sell something at a pre-defined time. Although, there is one key difference. Once you buy the options contract, thereafter you are not obligated to hold the terms of the agreement.

Benefits of Derivatives:

  1. It acts as a very good hedging tool against the volatility of price.
  2. It is a big plus point for margin traders as it offers huge time leverage.
  3. You can take a high exposure on a share by paying a small margin. For example, if the stocks are priced at Rs. 8 Lakhs and you only have 2 Lakhs in hand, then this product will still help you to take a position.

Use of Derivatives:

  1. You can earn money on stocks that are lying idle: If you don’t want to sell the shares you bought for long term, but want to take benefits of price fluctuations in short term. Then you can use derivative as an instrument. It helps you to conduct transactions without even selling your shares.
  2. Risk Transfer: The most important use of these derivatives is the transfer of risk from risk-averse investors to risk-loving investors. Those with an appetite for risk conduct risky trades to improve profits while risk-averse investors use derivatives to enhance safety. So by this way, risk is transferred.
  3. Benefit from arbitrage trading: When we buy low in one market and sell high in another market, it is called as arbitrage trading. Thus, you are taking benefit of differences in prices in the two markets.

Henceforth, these above mentioned points will empower you with the knowledge of derivatives. Also, for those who want to trade in derivatives, get started with Reliance Securities.