What are Derivatives in the Stock Market?

Derivatives have always been an integral part of the stock market. With their unique features and uses, they offer a great deal for traders to generate income and even help build long-term wealth. However, given the complexities of derivatives in the stock market, only seasoned traders used to trading derivatives earlier. However, now with an easy-to-understand online derivatives course, you can easily grasp the concepts of derivative trading and apply them in real life. 

Meaning of Derivatives and Derivative Trading 

As the name suggests, a Derivative is a financial contract that derives its value from an underlying asset. The contract defines the specified date in the future on which the trader can buy or sell the asset. 

By derivative trading, you can refer to trading these financial contracts where you pay a fraction of the total amount of the underlying asset’s price to buy or sell the contract. Thus, this is a form of leverage trading where you can buy more of the asset without actually paying the actual price of the same. The underlying assets for the derivative contracts can be any, ranging from equities to commodities, benchmark indices, and currencies as well. 

Types of Derivatives

Derivatives are mainly classified into Futures and Options; however, there are two other types of derivatives, which are Forwards and Swaps. In India, traders mostly deal in the Futures and Options category (F&O). 

Futures: These are financial contracts drawn between two parties for buying or selling a particular asset on a predefined date in the future at a predefined price. Both parties have to exercise the contract on or before the specified date. These are exchange-traded contracts. 
Forwards: Forwards are similar to Futures contracts, but they are not traded on the stock exchanges; but over the counter. 
Options: This is one of the most interesting categories of derivatives, where the buyer of the option contract gets the right to exercise the contract without any obligation, though. So, options are also financial contracts that offer the buyer the right to buy or sell the underlying asset at a predetermined price on a specified future date. Here, the buyer has the right and no obligation, which means, if the price of the underlying product doesn’t go in the direction the buyer predicted, he doesn’t have to honor the contract. Now options are further divided into call options, where the buyer gets the right to buy the underlying asset, while in put options, the buyer of the contract gets the right to sell the underlying asset.    
Swaps: These are financial contracts where the parties get to convert one type of cash flow into another. Interest rate swaps are one of the common examples of swaps. These are again primarily done over the counter and not on stock exchanges. 

Pros and Cons of Derivatives

The functions of the derivative market can be easily understood by the benefits and drawbacks of the derivative market. 

The advantages include – 

Hedging traders open positions in the cash market by applying different derivative trading strategies, which can limit the losses. You can learn these strategies in our derivative course, where you can also understand the derivatives market meaning in Hindi. 
Leverage trading helps traders buy a large quantity of the underlying assets with a small amount of capital. 

However, there are a few drawbacks to derivative trading if you jump into the market without understanding the fundamentals. 

Risk is high as these contracts play on the volatility of the market. 
If you are speculating rather than analyzing the market and the asset’s dynamics, then your trades can be at higher risk. 

You can reduce these risks by learning about derivatives in detail. 

How to Trade Derivatives?

So, for trading derivatives in the stock market, you need to – 

Open A Free Demat Account 
Then you need to add the margin amount to your trading account
Then, shortlist the derivative contracts available in the market. The contracts usually have a three-month expiry. Check the expiry date as you need to settle the contract on or before the expiry date, or it will be auto-settled. 

Open A Free Demat Account to start your Derivative Trading Today. 

Uses of Derivatives in the Stock Market

• If you have stock investments for long-term purposes, you can use them for derivative trading for short-term purposes as well. 
• You can use the derivatives for arbitrage trading 
• Using hedging methods, you can protect your stock investments with derivatives
• Derivatives can also be used to transfer risk from cautious investors to investors willing to take risks. 

Conclusion

So, if you are interested in diving into the world of derivatives, join the derivative course to understand how these financial contracts work in the real market. Once you know the concepts of derivatives and the F&O segment, it will be easy for you to trade derivatives in the stock market.