What Is Derivatives Trading

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What Is Futures & Options Trading

Imagine you’re eyeing a plot on the outskirts of Mumbai, expecting its value to rise due to an upcoming metro line. You decide to secure the deal by offering to buy the land six months later at the current price. To lock in this agreement, you pay an upfront fee of Rs 5 lakh.

Two scenarios can unfold:

  • Scenario A: Six months later, the metro is operational, and the land price has increased to Rs 70 lakh. You proceed with the purchase, paying the remaining amount (Rs 45 lakh). In this scenario, you make a profit as you get land worth Rs 70 lakh for Rs 50 lakh.
  • Scenario B: If the metro is delayed and the land price remains stagnant or drops to Rs 30 lakh, you choose not to proceed. The seller keeps the Rs 5 lakh advance fee as profit. Meanwhile, you walk away from the deal with a Rs 5 lakh loss.

This simple analogy sets the stage for understanding Futures & Options or derivatives trading in the Indian stock market.

Derivatives trading has garnered increasing popularity as it empowers traders to strategically hedge risks and enhance returns. However, it is important to develop a good understanding of this segment for successful trading.

In this article, we will cover the following:

  • What Is Derivatives Trading
  • Types Of Derivatives
  • How To Trade Derivatives
  • Benefits Of Derivatives Trading

If you’re ready to explore the potential of derivatives trading, opening an account with PL takes just a few minutes! Click here to start trading in F&O

What Is Derivatives Trading:

Derivatives are financial contracts that derive their value from the price movement of an underlying assets such as stocks, commodities, or indices. When trading in derivatives, a buyer and a seller get into a financial contract. These contracts include standardized specifications, including market lot, expiry day, price, and settlement method. Depending on the specific derivative type, traders may possess the right or obligation to execute the contract. Further, the capital required to enter a trade and the contract’s expiration also vary based on the derivative type.

Both the buyer and the seller aim to capitalize on the price fluctuations of the asset. Note that the value of a derivative is directly influenced by changes in the value of its underlying asset. Multiple factors contribute to these changes, including demand and supply dynamics, inflation, and the overall economic health.

By trading in derivatives, individuals can hedge and manage risks and potentially earn higher returns.

In India, derivatives primarily trade on major stock exchanges like the National Stock Exchange of India (NSE) and the Bombay Stock Exchange (BSE). Additionally, the Multi Commodity Exchange (MCX) and the National Commodity and Derivatives Exchange (NCDEX) facilitate derivatives trading for commodities like agricultural produce, metals, and energy products. The Securities and Exchange Board of India (SEBI) regulates the derivatives trading market.

You can trade in derivatives by opening an account with PL, within minutes!  Click here to start.

Types Of Derivatives

Popular types of derivatives traded in the stock market include:

Options: This type of derivatives gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price (the strike price) on or before a certain date (the expiration date). In Options trading, the buyer must pay a “premium”, while an Options seller has to set aside margin money. Here, the contract cycle could be weekly, monthly, and for long-dated options contract, the expiry could be 9 months to even 3 years.

Futures are a type of derivatives contract that obligates both parties to buy or sell an underlying asset at a specific price on a specific date in the future – irrespective of the market conditions at the time of expiry of the contract. The trader needs to keep a “margin money” (i.e., a certain percentage of the traded value). Here, the contract cycle could be of one month (near month), two months (next month) and three months (far month).

Swaps are a type of derivatives contract that involves conversion of one type of cash flow into another. It can be used to hedge against interest rate or currency risks.

Forwards are similar to Futures, but they are not traded on the exchange. This is in fact a customised agreement between two parties.

How To Trade Derivatives

It is important to understand the benefits as well as the risks when trading in derivatives. Ensure that you are well-informed about the type of derivative, asset class, factors impacting price movement, and broader market conditions. You should also be aware of your own risk appetite and financial goals.

This is where you can rely on advice from qualified experts at Prabhudas Lilladher. PL has a dedicated derivatives research desk comprising experts who can help you trade profitably in derivatives. PL’s research calls and reports have an excellent strike rate. Shilpa Rout, who heads PL’s derivatives research desk, has won the CNBC Awaaz Khiladi No 1 contest three times in a row.

For trading, you can use PL’s DigiTrade app or avail the call-and-trade facility so that you never miss out on any opportunities!

To trade in derivatives, follow these steps:

  • Step 1: Open an account with PL. You can open a trading account by filling out an application form and submitting the necessary documents for KYC, such as identity proof, address proof, and bank details.
  • Step 2: Research and decide the type of derivates & the trade that you wish to place.
  • Step 3: Add funds to your trading account and enter the details required to place the trade – example: select the asset and contract based on your funds, margin, and other relevant factors.
  • Step 4: Monitor your position and take appropriate action based on the evolving market condition.

By following these steps and leveraging PL’s expertise, you can navigate the derivatives market with confidence and make informed decisions to optimize your trading outcomes.

Benefits of Derivatives Trading:

Derivatives trading presents a range of benefits, including:

  • Risk Management: A powerful tool to hedge risk and shield against market uncertainties.
  • Capitalizing on Price Differences: Explore arbitrage opportunities by leveraging price differentials in various markets, maximizing potential returns.
  • Transparent Asset Valuation: Contributes to the efficient price discovery of assets.
  • Tailored Risk-Reward Profiles: Allows the creation of multiple payoff scenarios.
  • Capitalizing on Opportunities: Provides the potential to take advantage of even a non-directional market.
  • Cost Advantages: Derivatives transaction costs are generally lower compared to equity transactions.

To better understand futures and options in the stock market, start trading in detivatives with Prabhudas Lilladher, one of India’s most trusted financial services organisations.

With PL, you get timely research reports and actionable calls for efficient F&O trading. You can also participate in PL’s Live Market webinars. This will help you enhance your derivatives trading skills with hands-on knowledge and practical insights. So, open an account with PL now and start trading in F&O.

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