What do you mean by Derivatives Market?

Nilesh Jain

24 Nov 2016

Derivative is a type of financial instrument, whose value is derived from underlying assets. Underlying assets can be equities, interest rates, currencies and commodities. Derivatives are mainly used as a risk management tool where you can transfer the risk attached with the underlied asset to the party who is willing to take it. Risks can be Market Risk, Credit Risk and Liquidity Risk.

Understanding Derivatives Market

Who are the market participants in Derivatives market?

On the basis of their trading rationale, participants in Derivatives Market can be classified into three categories as follows:

Participants Of Derivatives Market

Arbitrageurs

Arbitrageurs exploit the price difference between two different markets. Arbitrage trade is a low risk trade where a trader simultaneously buys an asset at a cheaper rate from one market and sells it at a higher price in another market. Such opportunities are very short lived in derivatives market. Since an arbitrageur rushes to grab this opportunity, it eventually narrows down the price gap.

For example: The cash market price of ABC Ltd is trading at Rs.100 per share, but is quoting at Rs. 102 in the future market. An arbitrageur would buy 100 shares at Rs. 100 in the cash market & simultaneously, sell 100 shares at Rs. 102 in Future markets, thereby making a profit of Rs. 2 per share.

Hedgers:

Hedging in simple term means buying insurance to minimize the risk. An investor/trader who wants to protect himself from unfavorable price movements is called Hedger. The primary motive of an hedger is to limit his exposure risk. Hedgers try to hedge their positions by creating exact opposite position in the derivatives market.

For example: An investor has a portfolio of Rs. 5,00,000 and he does not want to liquidate his portfolio ahead of key events, such as budget, policy announcements or even elections. Hence, to protect his portfolio from volatility, he can short index futures to make his portfolio beta neutral or he can buy Put option by paying a fixed cost known as premiums

Speculator:

Speculators are risk takers, who are willing to take high risk in the anticipation of making higher gains in a short span of time. They tend to buy stocks with the expectation that the price will rise and then sell them at higher level. While in the process of making large profit, the probability of losing the principal amount is equally higher.

For example: If a speculator feels that the price of ABC company is likely to fall in a few days due to some upcoming market developments, he would short sell the ABC company’s share In a derivatives market. If the stock price falls as expected, then he would make good amount of profit depending on his holding. However, if stock prices shoot up against the expectation, then his loss would be equivalent.

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mutual-fund

Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market.  

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered.  

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest. 


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What do you mean by Derivatives Market?

Nilesh Jain

24 Nov 2016

Derivative is a type of financial instrument, whose value is derived from underlying assets. Underlying assets can be equities, interest rates, currencies and commodities. Derivatives are mainly used as a risk management tool where you can transfer the risk attached with the underlied asset to the party who is willing to take it. Risks can be Market Risk, Credit Risk and Liquidity Risk.

Understanding Derivatives Market

Who are the market participants in Derivatives market?

On the basis of their trading rationale, participants in Derivatives Market can be classified into three categories as follows:

Participants Of Derivatives Market

Arbitrageurs

Arbitrageurs exploit the price difference between two different markets. Arbitrage trade is a low risk trade where a trader simultaneously buys an asset at a cheaper rate from one market and sells it at a higher price in another market. Such opportunities are very short lived in derivatives market. Since an arbitrageur rushes to grab this opportunity, it eventually narrows down the price gap.

For example: The cash market price of ABC Ltd is trading at Rs.100 per share, but is quoting at Rs. 102 in the future market. An arbitrageur would buy 100 shares at Rs. 100 in the cash market & simultaneously, sell 100 shares at Rs. 102 in Future markets, thereby making a profit of Rs. 2 per share.

Hedgers:

Hedging in simple term means buying insurance to minimize the risk. An investor/trader who wants to protect himself from unfavorable price movements is called Hedger. The primary motive of an hedger is to limit his exposure risk. Hedgers try to hedge their positions by creating exact opposite position in the derivatives market.

For example: An investor has a portfolio of Rs. 5,00,000 and he does not want to liquidate his portfolio ahead of key events, such as budget, policy announcements or even elections. Hence, to protect his portfolio from volatility, he can short index futures to make his portfolio beta neutral or he can buy Put option by paying a fixed cost known as premiums

Speculator:

Speculators are risk takers, who are willing to take high risk in the anticipation of making higher gains in a short span of time. They tend to buy stocks with the expectation that the price will rise and then sell them at higher level. While in the process of making large profit, the probability of losing the principal amount is equally higher.

For example: If a speculator feels that the price of ABC company is likely to fall in a few days due to some upcoming market developments, he would short sell the ABC company’s share In a derivatives market. If the stock price falls as expected, then he would make good amount of profit depending on his holding. However, if stock prices shoot up against the expectation, then his loss would be equivalent.

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