Stock market has been on a developing stage in India and that’s why there is so much growth opportunities present in this market. Also there are many other types of instruments that need to be explored a lot in Indian stock market. There are few investing alternative that people don’t choose and doesn’t know about much. One such Alternative is derivatives trading.
Derivative trading is a trading whose value is decided based on the price of some other instrument/ asset. This asset is known as underlying or underlying asset in technical language. There are many forms of derivative trading and can be explained as follows:
- Forwards: Forward contract is a type of agreement between two parties (One buyer and other seller) who enters into the contract today to buy/ sell a particular commodity/ instrument at a future date at a price decided today. This price is the price of the forward contract. The profit/ Loss is decided by the price of the instrument/ commodity at the end of the contract. If the price increases by expiration then the long party (Person who is buying the underlying) benefits from the increase and vice versa. The main disadvantage of the forward contract is that it is not regulated by any authority or security exchange. So there is a risk of counterparty making default at the time of expiration of the contract.
- Futures: Futures contract were formed to overcome the shortcomings of the Forward contracts. Futures contract is traded on the standardized exchanges and is regulated by them. The contract is same as the forward contract and involves two parties entering into a contract and making payment according to the price of the underlying. The difference is that the exchange that acts as a clearing house require some margin requirement to be deposited by both the parties at the start of the contract. This margin acts as a guarantee of future performance and saves the clearing house from any loss. Also the contract is not settled at the expiration but is settled on daily basis according to the price movement of the underlying. This has helped a lot in decreasing counter party risk.
- Options: Options include call and put options. Call options give investor a right but there is no obligation to buy the asset. Whereas the put option implies a right but not an implied obligation on the party to sell the underlying. There is a premium that needs to be paid for buying options on any underlying.
- Swaps: Swaps involves exchange of payments at different intervals between two parties. The payment is based on the underlying and the underlying can be currency exchange rate, interest rates and even based on index.
There are many Discount brokers in India that charges zero brokerage from customers. The question arises then how do they earn revenue? The answer is by charging commissions in derivatives and Annual maintenance charges. But revenue generated from derivative is much higher. Layman may not have knowledge about derivatives but many professionals prefer to enter into derivatives contract and thus derivative trading is becoming popular day by day.
