How about availing 100% service value while utilizing only 10% capital? That’s the
beauty of derivative market. Derivative instruments derive their value from underlying
assets which can be Equity, Indices, Currency or Commodity. In derivative market
we can trade full contract value by utilizing very small amount as margin. Traders
generally use derivative contracts to earn maximum rewards out of available opportunities
by trading or to mitigate their risk by using hedging, arbitrage strategies. With
the availability of flexibility to design any strategy and play either side of markets,
derivative market becomes very interesting for traders or hedgers.
Derivative contracts have pre-defined margin requirements and expiry dates. They
are held at a recognized stock exchange where exchange acts as mediator and facilitator.
Derivative contracts are of two types – Futures and Options also known as F&O. Future
contracts are the one in which both buyer and seller exercise contracts by using
a nominal amount called as margin. At the end of the day the account gets adjusted
with notional profit/loss called mark-to-market and if the amount drops below minimum
margin requirements the account holder is required to deposit balance to continue
position or else the contract will be squared off. The contract will expire on squaring
off by client or on maturity date, whichever is earlier.
Option contracts are like insurance contracts where one pays premium to cover against
the adverse movement or else it expires on maturity date, in financial market it
is called Hedging. To make it more interesting option contracts also provide us
the platform to trade either side of markets and they are the cheapest instrument
available to enter the market. Option contracts are available with pre-defined strike
prices and they are of two types – Call options and Put options. If someone is bullish
on market then there are two ways – either Buy Call Option or Sell Put Option and
same way if someone is bearish on market then either they can Buy Put Option or
else Sell Call Option. If we buy an option then loss is limited to premium paid
only and profit potential is unlimited. If we sell an option then profit is limited
to premium received only and loss potential is unlimited.