Derivatives are financial products used for trading, but they have no inherent value, unlike Stocks and Commodities. Instead, Derivatives derive their value from assets like Commodities, Securities, Indices, etc. It is a contract between two parties, and the value of the contract is agreed-upon beforehand, based on the underlying assets. These are either used to mitigate risk called hedging or get used to taking risks with the expectation of a significant reward.
Futures, Forwards, Options, and Swaps are commonly implemented in the Derivatives Market.
Derivatives play a crucial role in stock markets, offering traders a means to manage risk and potentially achieve substantial rewards. Unlike stocks and commodities, derivatives derive their value from underlying assets such as securities, commodities, or indices. They function as contracts between two parties, with a pre-agreed value based on the underlying assets. Derivatives serve two primary purposes: hedging and speculative trading. Hedging involves using derivatives to mitigate risk, providing a safeguard against adverse market movements. On the other hand, derivatives can also be utilized for speculative trading, where traders take calculated risks in pursuit of significant rewards. Proper understanding and analysis of derivative products are essential to leverage their potential effectively. Platforms like VectorVest can offer valuable insights and tools to assist traders in comprehending and navigating the intricacies of derivatives in the stock market.
Table of Contents
Futures
Futures are an agreement between a seller and a buyer where the former enters the contract with a promise to buy or sell the underlying asset at a fixed price and date in the Future. Under Futures Trading, contracts are not traded for a single share but a fixed lot. The exchange decides the lot size. Every last Thursday of the month, Futures expire unless that day is a holiday, in which case, the contracts expire on the previous market day.
Options
Options give the buyer or the seller the right but not the obligation to honour the contract. In Options Trading, the price and delivery date are also agreed upon in advance. Options are of two kinds: Call and Put Options.The Call Optionprovides the buyer with the right but not the obligation to buy an asset at a pre-specified date for a particular period. The Put Option gives the seller the right to sell the underlying asset, but they are not obliged to carry out the trade.
Margins
Now while carrying trading, you should be mindful of margin. While Derivatives Trading, you need to pay a small margin. Pay the initial and Mark to Market (MTM) margin upfront before trading. While the initial margin covers the loss you face on 99% of the days, the MTM margin offers an assessment based on the current market condition. The margin amount also changes with every bet, so keep extra money in your account.
Forwards & Swaps
Forward Derivatives arecustomised contracts between two parties to buy/sell the underlying asset at a fixed price and date. These contracts are tailored according to the underlying asset, amount, and delivery date. On the other hand, Swaps are where two parties exchange liabilities from separate financial instruments. Of the two cash flows, the value is fixed, and that of the other is variable, usually based on the interest rates or index prices.
People Swap from a portfolio of Forward Contracts to a long position in one bond and a short position in another.
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