Everything You Need To Know About Stock Derivatives

Are you done investing in mutual funds? Want to try some other investment option? Try out derivatives. They are also called stock derivatives. Sounds complicated, right? It really isn’t. It is a financial instrument whose value you derive from the underlying security, which is the stock.

How does the derivatives market work?

Derivatives are of two kinds: futures and options. The future derivatives are a contract between two parties where they buy or sell the underlying stocks for a pre-decided price on a pre-decided date.

As for options, the parties are not obligated to buy or sell the underlying stocks for pre-decided price on a pre-decided date. You can exercise or leave the option. However, there is a cost for the option at which you will be buying it. If you do apply the option, your loss will be the price at which you purchased it.

Options are further divided into two types: call and put option. Under the call option, you can opt to buy the underlying shares while in the put option; you can select to sell the shares.

What are the uses of derivatives?

You can use derivatives to meet various needs:

  • Earn money on shares: You may not want to sell shares that you bought not for long-term but short-term, as you want to take advantage of the price fluctuations. The derivatives market in India allows you to conduct transactions without buying or selling your stock, which is called the physical settlement.
  • Arbitrage benefit: When you buy low in one market and sell for a higher price in the other market, it is termed arbitrage. You are making complete use of the costs in both the markets.
  • Protect securities: The derivatives market acts as a hedge against fall in the price of shares that you possess. It also provides you products that protect you from the rise in the number of shares that you plan to purchase.
  • Transfer of risk: One of the best uses of derivatives is the transfer of market risk from risk-averse investors to those with a high-risk appetite. Risk-averse investors use derivatives to boost safety while risk-loving investors use derivatives to improve profits.

How to trade in the derivatives market in India?

  • You first need to do thorough research. The strategies should be different from that of the stock market.
  • Make arrangements for requisite margin amount. Stock markets require you to maintain a marginal amount. You cannot withdraw this amount from your trading account until the trade settlement ends. Also, the margin amount fluctuates along with the rise and fall of the stock market. So, keep extra amount aside.
  • Conduct transactions from your trading account. Before that, check if you can use the trading account for the derivatives market. If not, ask the stockbroker to activate the services.
  • Once the trading account is in place, select the shares and the contracts depending on the margin amount you possess, the price of underlying stocks, the cost of contracts, etc. However, you have to pay a small price to buy the deal.

The prerequisites to use derivatives in the Indian share market are:

  • Demat account
  • Trading account
  • Maintenance of margin amount

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