The Indian secondary market which is commonly referred to as the stock market, allows you to trade in stocks and derivatives. Derivatives are amongst the most preferred choice of traders and investors due to a number of advantages over conventional stocks.
Derivatives are financial securities whose values are derived from an underlying asset or group of assets. Derivatives are contracts between two or more than two parties. Whenever there is a fluctuation in the price of the underlying asset, it affects the price of the derivative contract as well. These underlying assets can be stocks, indices, bonds, currencies or even commodities like silver, gold, crude oil etc.
Initially, derivatives served as a measure to balance the exchange rates for goods which are internationally traded. The values for international currencies are always fluctuating, thus there was a need for a system to account for differences. But in the modern times derivatives have many more uses and are based upon a variety of transactions.
Derivatives are traded on the stock exchanges and are also used by institutional investors for hedging risks and also to speculate the price changes in the value of the underlying asset. The derivatives which are traded on the exchanges are standardized and have lower risks compared to over the counter derivatives. Derivative instruments are leveraged instruments and thus have a high risk to reward ratio.
Without further ado, let us now discuss about the participants in the derivatives market.
1. Participants in the Derivatives Market
There are four major participants in the derivatives market, namely – hedgers, speculators, arbitrageurs and margin traders. Let us discuss about each one of them in detail:
Hedgers: There is a very active participation in the derivatives market by hedgers. If you are looking for hedging, derivative market is the perfect place for you. When a trader or investor invests in the markets with the aim of reducing risk of price volatility in exchange market, it is known as hedging. Derivatives provide excellent hedging options corresponding to the respective underlying asset. For example, if you have invested in Bank Nifty and simultaneously also bough Bank Nifty Futures in the derivatives market. So, in case if you incur any loss in your position in Bank Nifty, the same will be set off by your position in Bank Nifty Futures.
Underlying Asset Price Determination: Derivatives are often used in the market for determining the prices of the underlying assets. For instance, the spot prices of the future contracts may be used to get an approximate value of the underlying commodity.
Speculators: One of the most common strategies which financial investors use is speculation. Though it is very risky still it is preferred by the investors. Speculation or speculative investing is the strategy where an investor invests in any financial instrument or asset because you speculate that the same will be very valuable in the future. The main aim of speculation is to extract attractive profits from the market in the upcoming future.
Arbitrageurs: The global financial markets are very vast. It is next to impossible for any investor to have a direct access to every asset or market. Derivatives can help you in gaining access to all such unavailable assets and markets. You can use interest rate swaps and obtain much more favorable interest rates relative to interest rates available for direct borrowing.
Arbitrageurs: Arbitrageurs aim to extract profits from the price differences which arise in the investments made in the financial markets such as the bond market, stock market, derivative market etc. Arbitraging is a very common profit-making strategy which can be used in the financial markets and helps you in generating lucrative profits from the volatility in prices arising in the market.
Margin Traders: : If you are looking to directly invest in the derivative markets, you will fall under the category of margin traders. This is one of the prime advantages of trading in derivatives, that you can trade using high leverages and margins. When you do margin trading in the derivatives segment, you only need to pay the margin amount and not the entire amount. However, margin do vary from share to share and are usually fixed by the stock exchanges. Several factors such as the market volatility are taken into consideration for the calculation. Fox example, the margin requirement for XYZ is only 13 per cent. So if the cost is 1,00,000, you only need to pay an amount of 13,000, thus helping you in carrying out bigger trades with low capital.
2. Types of Contracts in Derivatives Market:
In the derivatives market, trading is done in the form of contracts known as derivatives contracts. These contracts are traded on the exchange as well as Over the Counter. There are mainly four different types of contracts which are traded in the derivatives market. These are used for speculation, risk management and leveraging a position. Derivatives are a growing marketplace and offer an instrument for almost every need and risk appetite. Types of derivative contracts include:
- Futures
- Options
- Forward Contracts
- Swap
Conclusion
Derivative market is a very lucrative alternative to the stock market due to a number of benefits. However, it can prove out to be one of the riskiest markets amongst all other financial markets, if traded without proper knowledge and experience. Before you step in the world of derivatives, it is better to get your risk profile analysis updated from a SEBI registered investment advisor, which will help you in getting an idea about your risk appetite. You can also take the help of Delta Derivative Plus and Equity Derivative Pack which will provide you with research-based recommendations for trading in the derivatives market.
Happy Trading!
