Derivative Trading

Derivative Trading

Derivatives are the complex instruments of the financial market whose value is derived from the underlying assets. The underlying assets can range from equity, index, bonds, interest rates, and even commodities. They are considered to be profit yielding vehicle for the seasoned traders and investors. Tracing back to its origin, the derivatives were introduced due to the high volatility in the capital market, for the sole purpose of hedging the positions. Ever since then, these products have gained huge popularity amongst the traders not only for hedging but for speculation as well. The derivatives trading helps institutional investors to reduce their potential risks as they have substantial market positions.

Derivatives Trading in India

In India, derivatives trading is humongous which can be highlighted by the fact that NSE notched up 6 billion contracts in 2019. Also, NSE was declared the world’s largest exchange surpassing the old Chicago Mercantile Exchange.

For derivative trading, there are three exchanges available in India namely the National Stock Exchange, Bombay Stock Exchange, and Multi Commodity Exchange. Through NSE and BSE, the derivative instruments available are stocks, bonds, and currency. While if you want to trade derivative in a commodity then MCX is the exchange.

What are the instruments available for derivatives trading in India?

The derivatives are broadly categorized into lock and options products. The lock products provide an obligation to the contractual party to the term over the life of the contract. Some of the examples are swaps, forward, and future. Whereas, the options contracts provide the buy with the right and not the obligation to enter the terms specified. The following points explain the commonly traded instruments in India:

Forward contract:

This is the agreement between the two parties to buy or sell the underlying asset in the future date at a prespecified price. These are traded over the counter and settled only when the deal is completed. A plethora of assets is traded via forward contracts like pulses, grains, oil, electricity, natural gas, and precious metals.

Futures contract:

Similar to the forward contract, it deals with the agreement between two parties to buy or sell an underlying asset at the future date. The main difference between both is the fact that in the futures contract, the parties need not enter into an agreement with each other but with the exchange. Also, the futures contract are standardized exchange-listed agreements that follow daily settlements.

Options:

This is one of the most layered products of the derivative segment but majorly traded. This is the agreement between two parties in which the buyer has the right but no obligation to buy or sell the underlying asset in the future date. While the seller of the options is obligated to buy or sell the underlying.

Swaps:

This instrument allows the parties to exchange their stream of cashflows. The most popular swap contracts are interest rate swaps and currency swaps.

Benefits of Derivatives Trading

High Leverage

When trading derivative instruments like futures and options, an investor can be exposed to a much greater value of the stocks than he could when buying the original stock. Generally, to trade in derivatives they have to put in a margin or fraction of the total amount of position.

High Liquidity

A relatively large volume of derivative products can be easily traded with the constant presence of buyers and sellers in the market. In India, there is a small percentage of stocks which also have their derivative products, are heavily traded.

Trading Cost is low

The trading costs are relatively lower and are charged only when the position is closed. However, it also depends on the broker type where Findoc aids the customer with the best brokerage available.

Determining the fair value

The derivative products derive their prices from the underlying assets which help in determining the prices of the assets as well. The spot price of a future instrument can give a fair estimation of the underlying commodity’s price.

Hedge risks

These instruments were introduced primarily for the sake of hedging positions in the capital market. Due to the high volatility, institutional investors hedge each position with relevant derivative products. For example, an investor can hedge their position in the stock by investing in the derivative product which moves in the opposite direction.

Easier short sellings

An investor can easily get exposed to shorting on a particular stock by selling futures or buying a put option which is not possible to accomplish otherwise. Even for intraday short selling stocks, an investor requires a margin account with their broker.

Why invest with FINDOC ?

We are the members of the National Stock Exchange (NSE), Bombay Stock Exchange (BSE), and provide depository services through NSDL.

The platform is well secured and equipped with progressive technology so that you can have access to everything required.

You can experience trading across devices like a mobile, desktop, tablet without any hassles.

If you are already one of our broking clients, you don’t need to open another account for derivative trading. The existing account will be authorized for this segment as well.

You can access our advanced fundamental and technical research on the current market via daily, weekly newsletter updates on our platform.

You don’t have to worry if you get stuck anywhere while using Findoc, the platform has dedicated customer service support.

Experience the advanced paperless investing with the platform.

Frequently Asked Questions

What is derivative trading in share?

Derivatives are financial instruments with no independent value of its own. The value of such securities is derived from the underlying assets like stocks, bonds, commodities, currencies, etc. They were initially developed for hedging but now account for two-thirds of total transactions globally. The two popular derivatives products traded in India are futures and options.

Can company trade in derivatives?

Yes, a company can buy and sell derivatives securities without registering itself as an NBFC. The NBFC (Non-banking Financial Cooperation) is an entity involved under the principal business of acquisition of shares/bonds, advancing loans, insurance business, trading in marketable securities, etc. If any company is not registered as NBFC under Companies Act, 2013, that means their principal business involves agriculture, industrial activity, trading of products (other than securities), providing services, or property dealing.

Is the stock a derivative?

No, stocks and derivatives are different securities while highly allied. The stock prices are derived from the supply and demand of the particular share, while the derivative prices are derived from that of the underlying. While the stocks are independently priced, the derivative is dependent. Basically, derivatives are the contracts between two parties whose price is determined by the underlying asset (like stocks, bonds, interest rates, etc).

What is the derivative formula?

With a different type of derivatives product, the pricing mechanism is different for each variant. The one thing similar to all of them is the fact that their pricing depends on the underlying instrument. The pricing of a futures contract depends on the spot price with the basis point. While that of an option contract depends on the time, volatility, and strike price.

Should I invest in derivatives?

Initially, derivatives were used only to hedge the positions but now they are a major part of the investor’s portfolio. Whether or not you should trade in derivatives depends on the like risk appetite. The derivatives provide huge exposure with a small capital emerging it to be a double-edged sword. Hence, if you can manage the risks associated and yield enough returns, this instrument is for you.

What is another word for derivatives?

The derivatives are sometimes interchangeably referred to with futures or options contracts in India. In origin, they are the types of derivatives contract which are mostly traded in the Indian market space.

What are the benefits of derivatives?

The derivatives trading was widely developed post-1970s when the financial market’s stability was questioned. While the usage of this instrument was not prevalent in India until June 2000. Such products impact financial space because of several benefits. o Helps in hedging your position effectively. o Access to huge exposure with a limited amount. o Helps in determining the price of the underlying security. o Helps in increasing the efficiency of the financial market. o Access to otherwise unavailable assets. o For speculative purposes.

Why do companies use derivatives?

The non-financial entities use derivatives to mitigate the risk that arises from the unexpected rise or fall in the product prices they deal with. For example- if a Basmati rice distributor has entered a future contract with the farmer to buy the product at a pre-specified rate at a later date then the company has mitigated price fluctuation risks.

How do derivatives manage risk?

The derivatives can be used to mitigate and manage risks when it comes to investors as well as companies dealing in the underlying. The investors look for the option to yield return while protecting any unforeseen risk by hedging with derivative products like futures or options. While the companies dealing in the underlying like commodities, manage risk by fixing the prices beforehand.

Derivative Trading Blogs

Types of Derivatives and Derivative Market

Another name for the financial markets is volatility. To curb the losses due to this characteristic, derivative products were introduced in the history of financial markets. Such instruments do not have their prices but derive their prices from the underlying assets like stocks, bonds, interest rates. The primary obj....

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Most Useful Derivative Strategies

Derivative Strategies are the way of using products like future, option, or a combination of them depending on the direction of the market or the individual stock. While formulating the strategy, the investor should keep in mind the factors like objective, the volatility of the underlying, viewpoint of the direction, and....

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Mistakes committed by traders while trading in derivatives

Committing mistakes is a part of the learning process when it comes to trading or investing. Investors are majorly involved in holdings for a longer duration and they will trade in stocks, exchange traded funds, and other securities. Traders generally buy and sell futures and options, hold those positions for shorter ....

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Disclaimer The information contained in this file is provided for informational purposes only, and should not be construed as legal advice on any matter. The content and interpretation of the law addressed herein is subject to revision. We disclaim all liability in respect to actions taken or not taken based on any or all the contents of this file to the fullest extent permitted by law. Every effort is made to avoid errors. In spite of that, errors and discrepancies may creep in. It is expressly stated that neither Findoc Investmart Private Limited nor any of the contributors of updates will be responsible for any damage to anybody on the basis of this document. Readers are, therefore, requested to cross check with the original sources e.g. Government publications, Orders, Judgments etc., before taking any action or making any decision. These services are being provided through our group companies Findoc Capital Mart Pvt Ltd and Findoc Finvest Private Limited

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Important Message The information contained in this file is provided for informational purposes only, and should not be construed as legal advice on any matter. The content and interpretation of the law addressed herein is subject to revision. We disclaim all liability in respect to actions taken or not taken based on any or all the contents of this file to the fullest extent permitted by law. Every effort is made to avoid errors. In spite of that, errors and discrepancies may creep in. It is expressly stated that neither Findoc Investmart Private Limited nor any of the contributors of updates will be responsible for any damage to anybody on the basis of this document. Readers are, therefore, requested to cross check with the original sources e.g. Government publications, Orders, Judgments etc., before taking any action or making any decision. These services are being provided through our group companies Findoc Capital Mart Pvt Ltd and Findoc Finvest Private Limited

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