What is a Derivatives Market: A derivative is an asset whose value is derived from an underlying asset, hence this derivative asset is called a derivative. For example: If a gold ring is made of gold, then the gold ring will be a derivative of gold. In the same way, the curd is made from milk, so curd is also a derivative of milk.
If we talk about the stock market, then the Nifty future is also a derivative whose value is formed by the price of all the shares included in Nifty. If we talk about a single share, then the price of Reliance Future Contract is derived from the price of Reliance Equity Shares.
Derivatives are not one but two things, one is the item or product which is the Underlying Asset and the other is the thing that is made up of this Underlying Asset. When there is a change in the price of the Underlying Asset, only then does the price of the Derivative Product change.
There are 3 types of derivatives -
1. Commodity Derivatives: All the commodities related to Consumption are called Commodity Derivatives like Rice, Crude Oil, Gold, Silver, etc. All those commodities which are consumed are all Commodity Derivatives.
2. Currency Derivatives: Rupee, Dollar, Pound are all examples of currency derivatives.
3. Equity Derivatives: All those contracts which are traded in the stock market are called Equity Derivatives such as Shares, Bonds, Debenture, etc.
How derivatives market works
A derivative contract is a promise that a buyer and seller make to each other. In which he buys any Currency, Commodity, or Share at some future date at a predetermined price and quantity. Since it is a promise, you do not need to pay the full amount in advance when the date on which you have contracted to buy or sell the goods is to be paid by taking delivery of the goods on that day.
It is not at all necessary that the promise made by the Buyer and Seller to each other should be fulfilled. When the expiry date of the contract approaches, the buyer and seller can also cancel this deal which is called square off the contract. If Buyer and Seller want, then this contract can be taken forward by one month which is called Rollover. (What Is Derivative In Share Market)
Why Derivatives Market is Important
The stock market is very volatile and many times large companies, traders, and investors are likely to suffer losses due to market volatility. In such a situation, he reduces his risk by buying and selling contracts in the derivatives market.
However, many stock market traders try to earn money by speculating in the derivatives market, in which they are successful many times and sometimes they have to face huge losses.
Types of Derivatives Contracts
There are 4 types of contracts in the derivatives market, the most popular being Future Contract and Options Contract, which we also know as F&O Market.
Forward Market: Forward contract is an OTC (Over The Counter) contract in which the buyer and seller make a contract together with no third party involved. This contract is risky.
Future Market: A futures contract is an exchange-traded contract that is traded on a stock exchange. This also happens between two people but this contract is exercised by the stock exchange, so there is no default in it.
Option Market: Option Contract is an Exchange Traded Contract which gives the right to any Buyer and Seller to buy and sell that Underlying Product at any future date but this contract is not binding.
Swap Market: This is not for common investors, in which cash flow is done from one side. The most common example of a Swap Contract is an Interest Rate Swap.
Difference between derivative market and equity cash market
According to the investment, there are two segments in the stock market, one is the equity cash segment and the other is a derivative segment.
When we buy a share in Equity Cash Market, then we have to pay the full amount for it like: If a share is worth 100 rupees, then 100 rupees will have to be paid for it. And we can keep that purchased share with us for as long as we want. Apart from this, short selling in the equity cash market is only for intraday.
Shares have to be bought in a pre-determined lot size in the Derivatives Market and you cannot keep that lot with you forever, but it has an expiry every month and has to be sold before that expiry. To buy shares in the derivative market, according to the market value of the share, the full amount is not paid, only some margin has to be paid. In the derivative market, you can hold short-selling till the expiry.
