The derivatives markets in India are gaining significance very fast. Its popularity can be seen or understand from the widely known fact that regular turnover in the derivatives trading segment on the National Stock Exchange around more than crore, that is the turnover more than cash markets on same exchange.
Derivatives are known as the financial contracts that derive their value from a spot price or underlying asset. Derivatives are available for stocks, commodities, indices, currencies, and interest rate. With the help of these financial instruments you can make profits. These financial instruments help you make profits from speculating on the future value of the underlying asset. Therefore, their values are derived from that of the underlying asset. That is why they are called ‘Derivatives’.
In other words you can well understand, for example, a farmer wants to enter into a contract to sell his grain at a future date to reduce or stop the risk of a change in prices by that date. Such a transaction would take place through a forward or futures market. This market is called as the “Derivatives Market”, and the entire prices of this market would be driven by the spot market price of wheat which is the “underlying”. The word “contracts” is often applied to indicate the specific traded instrument, whether it is a derivative contract in wheat, gold or equity shares. Derivatives are the key part of the financial system. The most important contract types are futures and options, and the most important underlying markets are commodities, equity, real estate, foreign exchange, etc.
Hence we can say that derivatives are financial contracts or agreement between two parties. The profit or loss depends on the performance of a specific underlying asset.
Types of Derivatives-
Basically two types of derivatives are exist privately traded derivatives and exchange traded derivatives.
In privately traded derivatives don’t go through an exchange or any other intermediate. In this type of derivative you can directly buy from financial services providers such as banks. While in exchange traded derivatives you can buy or sell through derivatives exchanges without the need or help to interact with an intermediary like a bank.
The four most common types of derivatives are futures, forwards, options and swaps. Among these derivatives swaps are complex instruments that are not available for trade in the stock market.
- Futures Derivatives-
Futures derivatives are known as contracts that represent an agreement to buy or sell a set of assets at a fix time in the future for a specified amount.
- Forward Derivatives-
Forwards are like futures, which are not standardized. They are not traded on a stock exchange. Forwards differ from futures in that they are privately negotiated and customized according to the buyers specific needs.
- Option Derivatives-
Options are quite similar to futures and forward, there is only one key difference that, once you buy an options contract, you are not obligated to hold the terms of the agreement. The buyer of an option will only exercise it if it is profitable to do so.
Use of Derivatives-
In the Indian markets, futures and options are standardized contracts, which can be freely traded on exchanges. Derivatives help companies manage risk and are increasingly used by firms seeking to protect themselves from the volatility of financial markets. The most common use of derivatives is to manage the risk of fluctuations in foreign currency.
Another common use of derivatives is to protect against changes in the rate of interest, or to take benefit of more favorable interest rates that a firm may not be able to access on their own.
The third most common use of derivatives is using these tools to manage fluctuations in commodity-price. For companies that work on primary commodities, price fluctuations can be very problematic for them. Derivatives allow such companies to lock in a price for a future sale or purchase of goods.
With the help of derivative market trading tips, you can absolutely earn profit and become a successful investor.