Derivatives trading occurs through futures or options contracts between two parties at stock exchanges like NSE and BSE and commodity exchanges like MCX, NCDEX, ICEX, etc. Some derivative instruments are also traded over the counter. The price of a derivatives contract depends on an underlying asset, such as a stock, index, currency, commodity, or even interest rates. Derivative prices are highly reactive to the underlying asset's price.
If the underlying asset's price increases, the derivative price may also increase and vice versa. Read on to learn about some popular derivative trading strategies expert investors rely on to make money from through this financial instrument.
However, while these strategies are time-tested, meaning they work on all market conditions, there is no holy grail method of making money from derivatives trading. It is always prudent to backtest the derivatives trading strategies enlisted here and find the one that best suits you.
Futures Trading Strategies
Futures traders trade in two directions - long (buy futures) or short (sell futures). Here are the four most popular futures trading strategies:
Long trades are a common form of trading futures. When you purchase futures, you feel confident that the price of the underlying asset will increase before the contract expiration date. The further the price goes above the price agreed by you and the seller (strike price), the more profits you can make.
Short trades refer to selling futures. When you sell a futures contract, it means you are confident that the price of the underlying asset will decrease before the contract expiration date. Short trades are generally considered riskier than long trades since the losses can be substantial if the price moves in the opposite direction.
Bull Calendar Spread
The trader buys and sells futures contracts on one underlying asset but for different expirations in this futures trading strategy. The trader usually goes long on the near-term expiry and short on the long-term expiry. Investors adopting this strategy expects the spread to widen in favour of long to increase their profit margin.
Bear Calendar Spread
Bear calendar spread is the opposite of the bull calendar spread. In this futures trading strategy, a trader goes short on the short-term contract and long on the long-term contract. Investors preferring this strategy expect the spread to widen in favour of short so as to make a higher profit.
Options Trading Strategies
Options are of two types - call and put. The call option gives a trader the right to purchase the underlying asset at a predecided price in the future. In contrast, the put option entitles the trader to sell the underlying asset at a predecided price in the future.
Here are the most common options trading strategies traders rely on:
Long call is one of the most popular investment instruments in options. You can place this trade when you are confident that the underlying asset and the corresponding strike price will go up before the contract expiry date. Remember, time is an enemy of options. The faster the underlying asset's price moves above the strike price, the faster you profit. However, if the price goes up on the final date of contract expiry, you may incur a loss.
When you buy put, you expect the underlying asset to go down in the future or before the contract expiration date. If the underlying asset drops below the strike price, you make a profit. However, if the asset price increases, your premium value (the price you paid to buy the put) may become zero.
Covered Call Strategy
In this options trading strategy, you buy an underlying asset in the spot market and sell a call of the same asset. This approach is adopted by investors who maintain a neutral to a bullish stance. In terms of the risk-reward ratio, the reward is limited, but the losses may be unlimited. Moreover, volatility might cause additional trouble for a trader relying on this strategy for making a profit.
Married Put Strategy
In this strategy, an investor buys a put option for the shares they already own or intend to buy. Investors who are generally bullish on a stock adopt this strategy to minimise the impact of a fall in prices.
Test Your Skills Now and Make Profits
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