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Trade in the Capital Market

A derivative is a formal financial contract that allows an investor to buy and sell an asset for a future date. The expiry date of a derivative contract is fixed and predetermined. Derivative trading in the share market is better than buying the underlying asset since the gains can be substantially inflated.

Derivatives can include a wide range of such assets including indices, currencies, exchange rates, commodities, stocks, or the rate of interest. The buyer and seller of such contracts have opposite estimations of the future trading price. Both the parties bet on the future value of the underlying assets to make a profit. Derivative trading is similar to a regular buy and sell process, but instead of paying the whole amount up front, a trader pays only an initial margin to a stockbroker.

Benefits of Derivatives Trading

Derivative Market is a financial market for trading in derivative which is widely used across the globe. If you are good at anticipating market movements, then derivative market is good for you to earn returns quickly. Some of the benefits of Dreivative Trading are discussed below:-

  • Gain Leverage - Derivative trading enables you to get higher trading exposure with a low margin amount.
  • Do Hedging - Derivative trading allows you to de-risk yourself by hedging your positions. You can buy in the cash segment and agree to sell in the derivative market or vice versa.
  • Opt for Risk as per choice - Derivative trading allows you to choose between conservative or high-risk strategies, These could be based on the expected rise and fall of stock prices/indices.
  • Access Higher Returns - With derivative trading, you have a possibility to get returns irrespective of market moving up, down or sideways.

Types of Derivative Market

Here are the list of various types of derivative market.

Future

A future contract is a legal agreement between two parties to buy or sell the underlying asset at a predetermined future date and price. The contract is executed directly through a regulated exchange.

Forwards

Forwards Contract are similar to futures except the deal is not made through an organised or regulated exchange. Since, these are OTC Contracts, they carry more counterparty risk for both parties.

Options

Option Trading allows you to buy and sell stocks. In other words, it contracts gives a trader the right but not an obligation to buy or sell an underlying asset at predetermined future date and price.

Swaps

A Swap is a contractual agreement between two parties to exchange cash flows at a future date based on a pre-planned formula. As they are OTC contracts and consequently not traded on exchanges.



Pros of derivative Market

derivative Market carries along with it some advantages which are discussed below:-

  • Low Transactions Costs - Derivative Contract play a part in reducing market transactions costs since they work as risk management tools. Thus, the cost of transaction in derivative stock trading is lower as compared to other securities like debentures and shares.
  • Used in Risk Management - The value of a derivative contract has a direct relation with the price of its underlying asset. Hence, derivatives are used to hedge the risk associated with changing price levels of the underlying asset.
  • Market Efficiency - Derivative Trading involves the practice of arbitrage which plays a vital role in ensuring that the market reaches equilibrium and the prices of the underlying assets are correct and often used to ascertain the underlying asset price.



Cons of Derivatives Market

Derivatives Market carries along with it some disadvantages which are discussed below:-

  • Involves High Risk - Derivative contracts are highly volatile as the value of underlying assets like shares keeps fluctuating rapidly. Thus, traders are exposed to the risk of incurring huge losses.
  • Counterparty Risk - Derivative contracts like futures that are traded on the on the exchanges like BSE and NSE are organised and regulated. But the OTC derivatives contracts like forward are not standardised.
  • Speculative in Nature - Derivatives contracts are commonly used as tools for speculation. Due to the high risk associated with it their unpredictable fluctuations in value often lead to huge losses.