The cash and derivative segments are the two primary categories into which the Indian financial market system may be divided. The cash market has consistently been popular among investors. However, during the past several years, India has seen a significant increase in the amount of trading in derivatives.
It has even managed to surpass the quantities of the cash category, making this turnover rise unusual and spectacular. Derivatives are now recognized as a perfect investment tool that is more than deserving of being very lucrative to investors thanks to this investor interest. To invest in derivatives, though, you must thoroughly understand them.
What is Derivative Trading?
In essence, derivatives are contracts whose value is derived from an underlying asset. Short-term financial instruments having a set expiration date are known as derivative contracts. Stocks, commodities, money, indexes, exchange rates, and interest rates can be the underlying assets. The market is used in derivative trading to purchase and sell these financial contracts. By foreseeing how the underlying asset’s price will change in the future, you may benefit from derivatives.
Types of Derivative Trading
A financial agreement between two parties that derives its value from an underlying asset, such as stocks, currencies, commodities, etc., is referred to as a derivative. Such products are successfully used by organizations in India to speculate on the price movement of the underlying asset, leverage holdings, or hedge a position. The derivatives market can trade four different kinds of assets.
Options Contract: An options contract grants the purchaser the right, but not the obligation, to buy or sell the underlying securities to another investor within a predetermined timeframe, depending on the specific type of options contract. The specified price for the securities in the options contract is referred to as the strike price, and the seller of the contract is known as the option’s writer.
Within an options contract, the buyer retains the flexibility to forego the exercise right, as they are not compelled to proceed after paying the premium to the option’s writer. There are two primary types of options contracts: call and put options.
Futures Contract: A futures contract in the realm of derivatives legally binds both parties to execute the agreement within a predefined period. The involved parties establish a set quantity of the underlying assets and a price to be paid by the buyer at a specified future date.
In contrast to options, the buyer or seller of futures must execute the contract before the expiry date. Futures contracts encompass a wide range of categories, including currency futures, index futures, and commodity futures.
Forwards: Forwards are financial agreements between two parties based on a predetermined quantity and price of the underlying securities to be fulfilled before the expiry date. Similar to futures, forwards require both parties to execute the contract before expiry. However, investors can only engage in such contracts through an Over-The-Counter trading market rather than a regulated stock market exchange.
Swaps: Swaps are financial instruments that enable two parties to exchange or swap their financial obligations or liabilities. Both parties define the cash flow within the contract based on an interest rate. Typically, one cash flow remains fixed while the other fluctuates based on a benchmark interest rate.
Difference between a futures and options contract
The distinction between a futures and an options contract is crucial. When it comes to options, the buyer or the seller can decide whether to use their right to purchase or sell the underlying asset or to let it expire when the contract is up. For a futures contract to be valid, both the buyer and the seller must act to fulfill their contractual obligations prior to the contract’s expiration.
Do derivatives have an impact on the underlying asset’s price?
Derivatives like futures and options can influence asset prices in the near term since they derive their value from the underlying assets. For instance, a bullish picture of the stock’s near-term price is painted when the number of individuals purchasing futures and call options with a certain stock as the underlying asset climbs dramatically. As a result, there is an increase in demand, which prompts investors to purchase additional shares of that company in the cash market, driving up stock prices Also visit- Stock Screener.
Conclusion
Derivative trading has emerged as a significant force in the Indian financial market, surpassing even the traditional cash market in trading volumes. These contracts, derived from underlying assets, offer investors a range of strategies to speculate, hedge, or leverage positions. Understanding the types of derivatives, including options, futures, forwards, and swaps, is crucial for successful trading. It’s important to note the distinction between options and futures contracts, where options provide flexibility while both parties in a futures contract must fulfill their obligations.
Derivatives can also impact the prices of underlying assets in the short term, highlighting their influence in the market. There are so many demat apps available, but for a seamless trading experience, explore the Kotak Securities app – a top-notch demat app that offers a user-friendly platform for managing your investments.
