If you want to trade in the capital market, you can take two routes. While the first is the cash market route, the second is the derivatives route. Earlier, derivatives trading was the territory of experts since not everyone understood the meaning or techniques of this form of investment. But presently, both novice and expert investors trade in the derivatives market.
As a result, the trading volume, turnover, and money-making opportunities in the derivatives market have been steadily increasing. Derivatives trading is much like cash market trading since you can begin your journey with a Demat and online trading account. However, the techniques and formalities of derivative trading are different from the cash market.
What is the Meaning of Derivative Trading?
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.
Moreover, derivative trading is a leveraged form of trading, meaning you can buy a large quantity of the underlying assets by paying a small amount. You can trade in different types of derivatives, such as stocks, commodities, currencies, benchmarks, etc.
Derivative contracts are of two types - futures and options. In essence, both are the same since the investor, and the seller predicts the price of the underlying asset for a specific future date. But, futures and options are different in that, in futures, both the buyer and seller are under the legal obligation to honour the contract on expiry.
However, in the case of options, the buyer or seller can buy/sell before expiry by exercising their rights or letting the contract expire without any exercise of rights. Options are of two types - Call option and Put option. Investors buy a Call option when they are confident that the underlying asset will go up. In contrast, they buy a Put option when they feel certain that the price of the underlying asset will come down.
Derivative Trading - The Prerequisites
As previously mentioned, you need a Demat account and an online trading account to trade in derivatives. 5paisa provides easy and quick online account opening for free. Click here to open an account now.
Once your account gets ready, you need to add sufficient funds to your account to buy or sell derivatives in the share market. The amount is proportionate to the margin amount required for the contract. You may contact the broker to know about the minimum investment needed to start derivatives trading.
Derivative Trading - The Top Benefits
1. Hedge Risks
Derivative trading lets you hedge your position in the cash market. For example, if you buy a positional stock in the cash market, you can buy a Put option in the derivative market. If the stock tumbles in the cash market, the value of your Put option will increase. Hence, your losses will be minimal or nil.
2. Low Expenses
Since derivative trading is primarily done to reduce risks, the charges are lower compared to shares or debentures.
3. Transfer Risks
Unlike stock trading, derivative trading allows you to transfer the risks to all stakeholders involved in the process. Hence, your risks reduce considerably.
Trade Derivatives Like a Pro
Derivative trading is easy but highly technical. Proper knowledge is essential to trade in derivatives efficiently. Check this space for more interesting articles to improve your knowledge and trade like a professional.