Derivatives, in the context of securities markets, are financial instruments whose value is derived from an underlying asset. This underlying asset can be anything from a stock, bond, commodity, or even a currency. The “derivative meaning” lies in the fact that their value is contingent upon the performance of another asset. The derivatives market is a wide, inclusive and complex ecosystem where these instruments are traded.
Trading derivatives involves buying or selling these instruments with the aim of profiting from price fluctuations in the underlying asset. There are various types of derivatives, including equity derivatives (based on stocks), currency derivatives (based on currencies), and share market derivatives (based on shares). The popularity of derivatives trading has led to the development of numerous derivatives apps, which offer tools and platforms for investors to trade these instruments efficiently.
Let us learn more about derivatives like stock market derivatives, futures and options trading and more below:
Types Of Derivatives
There are various types of derivatives depending on the asset classes. Let us look the asset classes and derivatives and its types in detail with examples below:
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Equity Derivatives
These are derivatives based on underlying stocks or stock market indices. Here are some of the commonly used equity derivatives in India:
- Futures: These are contracts obligating the buyer to purchase and the seller to sell a specified quantity of an underlying asset at a predetermined price on a future date.
- Options: Options as their name suggests are contracts granting the buyer the right, but not the obligation (option), to buy or sell an underlying asset at a predetermined price on or before a specified expiration date.
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Currency Derivatives
What are currency derivatives? Currency derivatives are derivatives based on underlying currencies. Common types of currency derivatives are as follows:
- Futures: Contracts obligating the buyer to purchase and the seller to sell a specified amount of a foreign currency at a predetermined exchange rate on a future date.
- Options: Options in currency work the same as options in equities. They are contracts granting the buyer the right, but not the obligation, to buy or sell a foreign currency at a predetermined exchange rate on or before a specified expiration date.
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Commodity Derivatives
These are derivatives based on underlying commodities, such as agricultural products, energy, or metals (gold, silver and more).
Types Of Options In Derivatives
In the Indian derivatives market, there are two main types of options: Let us look at types of options in derivatives:
1. Call Options
- Right To Buy: A call option gives the holder the right to buy an underlying asset (such as a stock, index, or commodity) at the strike price.
- Profit Potential: If the price of the underlying asset or security rises above the strike price, the holder can exercise the option and buy the asset at a lower price than the market price, making a profit.
2. Put Options
- Right to Sell: A put option gives the holder the right to sell an underlying asset at the strike price.
- Profit Potential: If the underlying security’s price falls below the strike price, the holder can exercise the option and sell the asset at a higher price than the market price, making a profit.
Options can be further categorised based on their expiration date:
- European Options: These can only be exercised on the expiration date.
- American Options: These can be exercised at any time before or on the expiration date.
Other than European and American types, options can be classified based on their underlying asset classes:
- Stock Options: These are based on underlying stocks listed on the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE).
- Index Options: These are based on underlying stock market indices such as the Nifty 50 or the Sensex.
- Commodity Options: These are based on underlying commodities traded on the Multi Commodity Exchange (MCX).
- Currency Options: These are based on underlying currencies traded on the National Commodity and Derivatives Exchange (NCDEX).
Understanding these different types of options is crucial for trading derivatives effectively in the Indian market. A derivatives app can help you understand these concepts with ease.
How Derivatives Market Works
The market derivatives market provides a platform for trading these financial instruments. Participants in the derivatives market include:
- Hedgers are individuals or institutions who use derivatives to reduce their exposure to price fluctuations in the underlying asset.
- Speculators are individuals or institutions who use derivatives to profit from price fluctuations in the underlying asset.
- Arbitrageurs are individuals or institutions who seek to profit from price discrepancies between related markets.
Derivatives Trading: What Are Derivatives Instruments
Derivative trading involves buying or selling derivative contracts. Traders can use various strategies, such as:
- Long Position: Buying a derivative contract with the expectation that the underlying asset’s price will increase.
- Short Position: Selling a derivative contract with the expectation that the underlying asset’s price will decrease.
While making decisions on demat account opening, you can look for the brokerage charges for these positions to make the most out of your trading experience.
Mutual Funds Investing In Derivatives Example
Exchange-Traded Funds (ETFs) are a type of mutual fund that trades on stock exchanges like stocks. Many ETFs in India invest in derivatives to track specific indices or asset classes. While ETFs can be a convenient way to invest in derivatives, it is important to understand the risks involved.
Here are some examples:
1. Index ETFs
- How they work: These ETFs use index futures to track the performance of a specific index like the Nifty 50 or Sensex.
- Benefits: They offer efficient exposure to a broad market index at a low cost.
2. Leveraged ETFs
- How they work: These ETFs use derivatives to amplify the returns or losses of the underlying index. For example, a 2x leveraged Nifty 50 ETF aims to deliver twice the daily return of the Nifty 50 index.
- Risks: Leveraged ETFs can be highly volatile and carry increased risks.
3. Inverse ETFs
- How they work: These ETFs use derivatives to profit when the underlying index declines. For example, an inverse Nifty 50 ETF aims to profit when the Nifty 50 index falls.
- Risks: Inverse ETFs can be highly volatile and carry increased risks.
4. Commodity ETFs
- How they work: These ETFs use futures contracts to invest in commodities like gold, silver, and more.
- Benefits: They offer exposure to commodities without the need for physical storage.
5. Currency ETFs
- How they work: These ETFs use currency futures to invest in foreign currencies.
- Benefits: They offer exposure to foreign currencies without the need for currency exchange.
Do you have further questions on financial derivatives?
Questions like these:
- What is derivatives meaning in share market?
- What are derivatives in finance?
- What are financing and derivative structures?
- What commonly used swaps in derivatives markets are?
A Demat app can help you get answers to these questions and trade in derivatives with ease.
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Conclusion
Derivatives are complex financial instruments that can be used for various purposes, including risk management, speculation, and arbitrage. Understanding the different types of derivatives, how they work, and the risks involved is crucial for anyone considering trading them. For hassle-free, risk-smart and smooth trading experience, download the HDFC Sky app.
