Derivatives Trading: What Is It All About and How Does It Work?

Derivatives are basically a financial contract with a value that has been derived from an asset. By asset, it may include currencies, indices, interest rate, exchange rate, or commodities. So, what are derivatives trading? It is a form of trading in which a person can make a profit through betting on what the value of the asset would be in the future. Additional profits are made by guessing the price right. Want more info? Continue reading the article.

 2 Main Kinds of Derivatives

There are 2 main kinds of derivatives – options and futures. With options derivative, the seller has the right to sell or buy an asset at any time during the contract’s life and at a specific price. On the other hand, futures derivative is a kind of derivative that obliges the buyer to purchase an asset while the seller should deliver it at a specific date in the future.

How Derivatives Trading Work

The trader needs to avail derivative instruments from registered stock exchanges trading members. First time investors would need to fill up a Know Your Client(KYC) Form. After that, the investors will receive an identification number. Now, the derivatives can be traded either through the help of a broker or through an exchange. Over-the-counter trading is also possible, especially for professional traders who are knowledgeable about the risk involved in it.

The Advantages of Derivatives Trading

One of the advantages of derivatives trading is that it allows people to engage in transactions without the need for them to sell their sales. This kind of trading also allows them to protect their securities from price fluctuations. It is also a great way to transfer risk and enhance safety.

Trading in The Derivatives Market

When it comes to conducting transactions, the trader should first ensure that their account allows derivative trading. In this case, consulting a brokerage may be necessary to have the services activated. After that, they can start selecting their stocks and its contracts. Buying the contract may require some money. When it’s scheduled to expiration, the trader can either enter an opposing trade or pay for the amount outstanding.

There are 3 requirements for derivatives trading – trading account, margin maintenance and demat account. The trading account is the one used for making trades. The account number serves as the trader’s identity. The demat account, on the other hand, is the one that stores the securities in an electronic format. This account is unique to each trader. A trader should also maintain a specific cash amount (margin) on their account so that they can start trading.

Final Thoughts

Mostly, the people who participate in derivatives trading are speculators and hedgers. The hedgers are the ones who are at risk of the price movements in the cash markets while the speculators take on a view of the market and based on it. They can either make or lose money. They use the derivative market to boost their profits.

Categories: Stock Market

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December 27, 2017 Derivatives Trading: What Is It All About and How Does It Work?