You may have often heard of the term ‘derivatives’ if you are familiar with
equity trading.
Several seasoned investors leverage derivatives to their advantage for better risk-return
trade-offs.
Here is all you want to know about derivatives.
Meaning of Derivatives
Derivatives are financial contracts that derive their value from underlying assets such as
stocks, commodities, currencies, bonds, and market indices. This value is subject to change
based on market conditions.
Benefits of Derivatives
As you know, volatility and market fluctuations are common in the stock market. There is a
risk of losing money. Derivatives can cushion you against this loss. Hence, most investors
use derivatives to transfer risk or speculate and make money.
They allow you to buy assets from the market at a lower price or sell at a higher price than
the prevailing market price. They give you a right or obligation to buy or sell the asset at the
prefixed price on or before a specified date on the contract.
Derivatives also give you an arbitrage advantage. It means that you can buy an asset at a
lower price in one market and sell it at a higher price in another market.
If you are an amateur investor and want to understand the advantages of derivatives in
Types of Derivatives
There are four types of derivatives:
1. Futures
It is an agreement in which you can buy or sell an asset at a future date at a predetermined
price. Both parties – the buyer and seller are under obligation to fulfill the contract. Futures
are traded on the stock exchange.
2. Options
In the options, the buyer of the contract has the right but no obligation to buy or sell the
asset at the prefixed price.
There are two types of options:
? The ‘call’ option gives the buyer the right to buy the asset at a strike price on the
prefixed price.
? The ‘put’ option gives the buyer the right to sell the asset at a predetermined price on a
specific date.
3. Forwards
Forwards are customized contracts in which both parties enter into a contract to trade an
asset based on their assumptions of price movements. However, forwards are not traded in
stock exchanges because they are unstandardized and available over the counter.
4. Swaps
Swaps are derivatives in which both parties exchange their financial obligations. It allows
cash flow exchange between them. Like forwards, swaps are also not traded in stock
exchanges and are available over the counter.
You can start your journey in derivatives with the help of Ajmera x-change, the
bestpractical advice to manage your money through derivatives in the stock market. Get in
touch to book a consultation session.