Do you know that most of the trading in the world takes place in derivatives and famous traders of the world trade in derivatives? So What is Derivative Market?
Whether you’re new to Trading or looking for new ways to trade in the Stock Market. You must have heard the term “Derivative”. Derivatives are contracts that involve risk. So Today, We will understand each and every aspect of Derivatives.
There are two ways to trade in the Stock Market. The first one is the Cash Market and the other one is Derivative Market. Earlier, derivatives trading was done by only experienced Traders but presently, both novice and experienced Traders trade in Derivatives Market. So Let’s begin with the What is Derivative Market? or Meaning of Derivatives?
What are derivatives in the Stock Market?
Before knowing what Derivative Market is, We get to know what the derivatives mean.
What is Derivative Market? : Derivatives mean coming from something else or based on something else. The basis on which a derivative is based is called the underlying asset, and the price of each derivative depends on its underlying asset.
If the price of the derivative increases then the price of the underlying asset increases, on the other hand, if the price of the underlying asset decreases, then the price of the derivative will decrease.
Ex- We know that sugar is derived from sugarcane, so we will say that sugar is the derivative of sugarcane here and sugarcane is the underlying asset here. When the price of sugarcane increases, the price of sugar in the market also increases, and when the price of sugarcane decreases, then the price of sugar in the market also decreases.
Similarly, there are Financial Derivatives in the Stock Market, their underlying assets are Stocks, Index, Currency, and Commodity, and just as the price change of these underlying assets changes, similarly the price change of derivatives is based on them.
Now I hope you got your answer, What is Derivative Market?
Types of Derivatives in the Stock Market
There are four major types of contracts in the derivatives market which are as follows:
A Financial derivative represents a contract sold by one to another party. Option Contract offers the buyer the right, but not the obligation to buy or sell a security or other financial asset at an agreed-upon price during a certain period or a specific date.
The option buyers can exercise their option contract at any time before the expiry date of the term. Apart from this, the person who sells the option is called an option writer or an options seller.
A Future contract is an agreement between two the buyer and seller to buy or sell something at the future date. The Future Contract trades on a stock exchange and is subject to a daily settlement procedure.
These contracts are traded on the stock exchange like NSE & BSE. The price of a futures contract changes every day depending on the market conditions in the Stock market.
This means that A Futures Trader can trade as per the market movement till the expiry date of the futures contract.
Forwards contracts are similar to futures contracts in that the holder is obliged to perform the contract. But Forwards Contracts are not standardized so they are not traded on Stock Exchanges(NSE & BSE).
Forward contracts are over-the-counter trades. These contracts are negotiated between two parties on a fixed date at a predetermined price in the future. This process is called a forward contract.
Swaps Contracts are derivative contracts in which two private parties exchange their cash flows. Swaps are the toughest and riskiest of all the above-mentioned contracts, Swap contracts are not traded on any exchange like NSE & BSE, Swaps Contracts are traded by derivatives and are traded on the over-the-counter.
How to trade in the Derivatives Market?
Although you saw above that there are a total of four major contracts, We can trade only in Futures and Options, So now let us see how to Trade in Futures and Options.
How to Trade in Futures?
Starting in Futures Trading is very easy. All you need to do is open a Demat & Trading account with a broker, Then you can start trading in futures. But Remember, You cannot do futures Trading in every stock. It is the decision of the exchange in which shares Futures Trading can be done.
Apart from this, Trading in the market index can be done only through Options and Futures Trading. Indices are made by mixing a group of many stocks, for example, the Nifty 50 is an index made up of 50 companies in India, These indexes are made by the exchange.
Let’s understand through an example, Suppose you think that the market is going to fall in the next one month. In this situation, you can sell the futures on the expiry of one month and then you will profit as soon as the market falls. Apart from this, Day traders also do futures trading to profit from the ups and downs of the Stock Market.
How to Trade in Options?
Options Trading can seem a little bit complicated compared to Stock Trading or Future Trading. In Options Trading, When you buy a share, you just decide how many shares you want, and your broker places the order at the current market price or the price you set. But Options Trading requires an understanding of the right skills & Strategies.
Which direction you expect the price of a stock or index to move determines which type of option you should Buy or Sell:
- If you think the stock price will rise: Buy a Call Option or Sell a Put Option.
- If you believe the stock price will remain stable: Sell the call Option and Sell the Put Option.
- If you think the stock price will fall: Buy a Put Option or Sell a Call Option.
Note – In Options Trading, The tendency of the option seller to make money is higher than the Option Buyers because the option buyer can earn money only when his option is rapidly moving in the specified direction. But the Option Sellers will still make money if the option goes in its direction and will still make money if the stock or index is going to be sideways.
Risk in Derivative Market
The derivative market is much riskier than the equity market because here You can buy or sell stock or index only a lot. Here You can not buy shares in quantity. Future trading is much riskier but Option Trading is riskier than equity and Futures. So If you want to trade in Derivatives, make sure you have proper knowledge about the Future, Options, and Market Psychology.
If you are a small Trader, I suggest you trade based on your risk capacity.
So Guys, Hope everyone is enjoying this reading. If You have any doubt related to What is Derivative Market?, So You can comment below this post.