What is Derivatives Trading?: A derivative is a financial contract whose value is derived from its underlying asset. Derivatives are the most popular way of trading in the stock market because in this any commodity or stock can be bought and sold without taking delivery. The shares bought in derivative trading do not come in the Demat account, derivative trading is done to take advantage of the fluctuations in the price of any commodity or stock.
I have already written a post on what is Derivative, if you do not know what is Derivative then you must read that post. In today’s post, we will talk about what is derivative trading and how to do derivative trading.
How To Start Derivatives Trading In India
Derivative trading is done through the stock exchange but you cannot buy and sell derivative contracts directly from the stock exchange. For this, a trading account has to be opened with a stockbroker. To start future trading in derivatives, 2 to 5 lakh rupees are required and to start options trading, 50 thousand to 1 lakh rupees are required.
Future and Option are both leveraged products and to take trade in this, only margin amount has to be kept in the trading account and till the trade is completed, that margin amount cannot be withdrawn. Derivative trading is suitable for those people who want to make quick profits by taking trades in the short term or who want to hedge their portfolios.
Types of Derivatives Trading
Derivative trading is done in 2 types, one is futures trading, and the other is options trading. Which we also call F&O Trading. There are 3 futures or options contracts available for trading at any given time. The derivative contract has a maximum validity of 3 months. A futures and options contract expires on the last Thursday of every month that was opened 3 months ago.
1. Futures Trading: Futures trading is a contract that gives two parties the right to buy or sell an asset (stock, currency, or commodity) at a predetermined price and quantity at a future date. This contract is fully binding i.e. that trade has to be completed at a future date. All futures contracts have an expiry and that contract has to be closed before that expiry. Otherwise, the penalty has to be paid.
2. Option Trading: To buy an option contract, only some premium has to be paid, in exchange for which one can buy or sell an asset (stock, currency, or commodity) at a predetermined price and quantity at a future date. Option trading contract is not fully bound. Traders can cancel the deal if they wish, but in return, they do not get their premium back. (What Is Derivatives Trading In Stock Market)
Where can Derivative Trading be done?
1. Currency Derivatives: In currency derivatives, a contract is made to buy or sell a currency such as Rupee, Dollar, Euro, etc. The currency of any country keeps on fluctuating, and trade is taken in them to save their old investment from the same fluctuations or to earn profit by buying contracts of new currency.
2. Equity Derivatives: Equity Derivative Trading is the buying or selling of futures contracts of shares of companies listed on the stock exchange. Eg: Futures contract of Reliance, Futures contract of Tata Motors, etc.
3. Commodity Derivatives: In Commodity Derivatives, a contract is made to buy or sell a commodity like Barley, Wheat, Soyabean, Coriander, Cumin, Turmeric, Gold, Silver, Crude Oil, Natural Gas, etc.
Things to keep in mind regarding Derivatives
Lot Size: In derivative trading, you cannot buy shares according to your mind, but shares are bought in a pre-determined lot size.
Margin: All the shares purchased in derivative trading do not have to be paid in full, but shares are bought by giving some percentage margin. Different margins are charged for all stocks, commodities, and currencies depending on the risk involved.
Expiry: All futures and options contracts expire every month and in exchange for the new contracts come into the market. You can buy Future And Options Contracts ranging from 1 month to 3 months.
Hedging: Hedging is a method that protects an investor’s money from market volatility. Hedging is done with the help of the derivative market.
Speculation: Taking trade in any stock or commodity on the basis of technical analysis is called speculation. Only technical analysis is used to take advantage of the derivative market.
