How to Deal in Derivatives Market

What are Derivatives?

Derivatives are the financial contracts or agreements that obtain their value from an underlying asset. These underlying assets could be commodities, stocks, indices, equity, rate of interest, currency exchange, exchange rates etc. From the last few decades, there has been an immense growth in the derivative market. The main reason for such tremendous growth are:

• Increased variations in underlying asset values
• Improved understanding of market associates
• Union of financial markets worldwide
• Continuous innovations in derivatives markets
• Advanced risk management instruments to handle the risk

Use of Derivatives

There are four types of derivatives, and all of them are famous and can be freely traded on exchanges. These derivative market instruments could be used to meet a wide range of needs.

1. Transfer of risk

The essential use of derivatives is to transfer the market risk from risk cautious traders to those who are longing for the risk. Most of the risk cautious traders use derivatives to improve safety. But on the other hand, risk-taking investors such as speculators lead risky and adversary trades to make more profit. So, in this way, the risk is transferred from one investor to others who love to take risks. To transfer your peril, there are numerous strategies and products available.

2. Benefit From Arbitrage

Arbitrage trading is all about taking advantage of variations in prices in two markets. When an investor buys an asset on all price from one market and sells on high price in the other market, this type of trading is called arbitrage trading.

3. Earn profits on shares that are idle

Some investors keep shares for a very long time without selling them, but on the other hand, they also want to take the benefit of the price fluctuation in the market in the short term. So, those investors can use derivatives market instruments. The derivative market allows those investors to do transactions without even selling their shares. This type of trading is known as a physical settlement.

4. Shield Your Securities 

The derivative market also provides the products that authorise you to hedge yourself in case of a fall in the value of shares that you have. It also provides products that save you from a rise in the price of stocks that you are planning to buy. This type of phenomenon is called hedging. Through hedging, you can save your securities against the variations in the prices in the market.

Types of Derivative

Mainly there are four types of derivative products which are: futures, forwards, options and swaps. Swaps are more complex derivative instruments compare to other three derivatives instruments. Also, swaps are not available for trading in the stock markets.

1. Futures

Futures are kind of contracts that shows an agreement to buy or sell a set of assets at a certain time in the future for a defined amount. Also, the transaction in futures is made by a regulated and organised exchange. 

2. Forwards

Forwards are over the counter (OTC) contracts. Forwards are a type of contractual agreement between two parties to buy and sell an asset at a particular time in the future. The contract between the two parties is also customised, and the price is negotiated. In other words, we can say that forwards are somewhat futures, which are not standardised. Forwards are also not traded on a stock exchange.

3. Options

Options contracts are pretty alike to forwards and futures. It gives an investor the right but not an obligation. It means once an investor buys options, he/she is not obliged to buy and sell the contract before a particular and at a fixed price.

4. Swaps

Swaps are a type of an agreement that is made between two participants in order to exchange the cash flows in the future as per a pre-decided formula. 

How to Trade in Derivatives Market

Trading in derivative market is very much similar to the stock market.

1. First do your research or take expert advice

It is essential in the derivatives market to do firm research or take advice from experts. Because the strategies that are required, differ from the stock market. Also, the traders are advised to keep in mind that the derivative market requires a time-bound and accurate view. The traders need to stay alert abut the expiry day; otherwise, it will automatically settle down on the expiry day that may cause huge loss.

2. Arrange for the essential margin amount

The rules of stock market need traders to maintain the margin account. It means you are not allowed to withdraw from your account until the trade is not completed. One more thing to keep in mind is that the margin amount changes according to the underlying stock. So, always keep the fund in your account.

3. Do the transaction by your trading account

To start trading in the derivatives market, investors need to activate the service in their account. To check whether your accounts allows you to trade in the derivatives market, consult with your stock broker or brokerage firm.

4. Always select those contracts which fit into your budget. You need to pay a small amount to buy any contract but make sure it fits in your budget.

5. Now you wait until the contract is scheduled to expiry to settle the trade.

Bottom Line

So now know everything about derivatives market instruments. If the benefits of the derivative market have fascinated you enough to start derivative market trading right away, then begin the process by choosing a perfect broker for you. If you are facing some issues finding a good and trusty brokerage firm, then let me help you in this. Oinvest is one of the top leading brokers who has been in this industry for a long time. For more details, you can visit their official website.