Understanding the Concept of Derivatives Trading

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If you’d like to trade in the capital market, there are two options: the cash market route and the derivatives route. Previously, derivatives trading was the exclusive arena for experts because everyone did not have a thorough understanding of the meaning or techniques of this investment form. However, at present amateur traders as well as pro traders can participate in the derivatives market. Visit MultiBank Group

Consequently, the outcome, the trading volume, turnover, as well as money-making opportunities in the derivatives market are on the rise. Derivatives trading is similar to cash market trading as you start your journey with a Demat and online trading account though there’s a difference in the techniques and formalities of derivative trading.

What is derivative trading?

A derivative is essentially a formal financial contract which enables an investor to purchase and sell an asset for a future date. The date of expiry of a derivative contract is fixed and preset. Derivative trading in the share market is far greater than actually purchasing the underlying asset as the profits could be remarkably inflated.

Additionally, derivative trading is a leveraged form of trading which implies that you will be able to purchase a large quantity of the underlying assets by paying a nominal amount. You will be able to trade a variety of derivatives like stocks, commodities, currencies, benchmarks, etc.

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There are two types of derivative contracts, namely, futures and options. The two are essentially the same as the investor, and the seller speculates the price of the underlying asset for a particular future date. However, futures, as well as options, differ in the sense that in the case of futures, buyers, as well as sellers, are legally obliged to adhere to the contract on expiry.

But if we talk about options, the buyer or seller will be able to purchase or sell prior to the expiry by exercising their rights or allowing the contract to expire without exercising any rights. Options also have two different types: Call option and Put option. Investors purchase a Call option when they’re sure that the underlying asset may go up. In contrast, they purchase a Put option if they’re sure that the rate of an underlying asset will reduce.

Prerequisites for derivative trading

You require a Demat account as well as an online trading account to trade in derivatives.

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When your account is ready, you must deposit sufficient funds to your account to be able to trade derivatives in the share market. This sum is in proportion to the margin amount required for the contract. You could get in touch with the broker to be familiar with the minimum investment required to begin derivatives trading.

Benefits of derivative trading

  1. Hedge Risks

Derivative trading allows you to hedge your position in the cash market. For instance, if you purchase a positional stock in the cash market, you will be able to purchase a Put option in the derivative market. In case the stock tumbles in the cash market, the value of your Put option would go up negating or eliminating your losses.

  1. Low Expenses

The charges are relatively lower than those for shares or debentures.

  1. Transfer Risks

Derivative trading makes it easier to transfer the risks to all stakeholders who are part of the process. Thus, you can bring down the risk.

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