People invest money in the financial market with the hope of making good returns. But the investment may turn risky due to volatility in the prices of securities like commodities, currency, equity, etc. During such fluctuations, all the predictions could go either way. This increases the chances of wiping out your entire investments. Thus, the primary concern of the trader is the risk that is associated with the financial market and flow of returns while trading in the market.
There are various instruments available that can protect a trader from the risks and volatility of the financial markets. These instruments not only protect the traders but even guarantees returns to them. Derivatives are such instruments. In fact, you will be surprised to know about just the types of derivatives market that exist. In this article, we will understand the concept and different types of financial derivatives in detail.
Before understanding the types of financial derivatives, let us first learn the meaning of derivatives.
What are Derivatives?
Derivatives are financial contracts that derive their value from an underlying asset. The value of the underlying asset keeps on changing depending on the market conditions. The derivatives can be traded by predicting the future price movement of the underlying asset.
The derivatives contracts are widely used to speculate and make good returns. These are used for various purposes like hedging, access to additional assets, etc.
Let us now learn about the different types of derivatives market in India.
Different Types of Derivatives in India
There are four types of derivatives that can be traded in the Indian stock market. Each type of derivative differs from the other and has different contract conditions, risk factor, etc. The different types of derivatives are as follows:
• Forward Contracts
• Future Contracts
• Options Contracts
• Swap Contracts
Let us now study the different types of financial derivatives in detail.
• Forward Contracts
When two parties enter into an agreement to buy or sell an underlying asset at a specified date and at an agreed price in the future, it is termed as a forward contract. Forward contracts are an agreement between the parties to sell something on a future date. The forward contracts are customised and have high counterparty risk. Since the contract is customised, the size of the contract depends on the term of the contract. Forward contracts are self-regulated and no collateral is required for the same. The forward contract's settlement is done on the maturity date and hence they must be reversed by the expiry period.
• Futures Contracts
Just like the forward contract, a futures contract is an agreement to buy or sell an underlying instrument at a specified price on a future date. In the futures contract, the buyer and seller are not required to meet each other to enter into an agreement. In fact, the agreement between them is done via exchange. Since there is a standardised contract in the futures contract, the counterparty risk is very low. In addition, the clearing house acts as a counterparty to the parties of the contract which further reduces the credit risk. Being a standardised contract, its size is fixed and it is regulated by the stock exchange. Since the future contracts are listed on the stock exchange and being standard in nature, these contracts cannot be modified in any way. To put it in simple words, future contracts have pre-decided format, pre-decided expiry period and pre-decided size. In future contracts, initial margin is required as collateral and settlement is done on a daily basis.
• Option Contracts
Options contracts are the third type of derivatives contract. Options contracts are very different from futures and forwards contracts as there is no compulsion to discharge the contract on a certain date. Options contracts are those contracts that give the right but not the obligation to buy or sell an underlying asset. There are two types of options: call and put. In the call option, the buyer has the right to buy an underlying asset at a price determined while entering the contract. While in the put option, the buyer has the right but not the obligation to sell an underlying asset at a price determined while entering the contract. In both the contracts the buyer has the option to settle the contracts on or before the expiry period. Therefore anyone trading in the options contract has the option of taking any of the 4 positions i.e. long or short in either the put option or the call option. Options are traded at over the counter market and at the stock exchange.
• Swap Contracts
Out of the various types of derivatives contracts, swap contracts are the most complicated. Swap contracts are private agreements between two parties. The parties to the contract agree to exchange their cash flow in the future as per a predetermined formula. The underlying security under swap contracts is interest rate or currency. Since both interest rate and currency are volatile in nature, it makes swap contracts risky. Swap contracts protect the parties from various risks. These contracts are not traded on the exchanges and investment bankers are the middlemen to these contracts.
To conclude, derivatives contracts like forwards, futures and options are one of the best hedging instruments. The traders can predict future price movements and make good profits out of them. For further assistance regarding derivatives contracts trading, you can contact IndiaNivesh who can assist you with trading in derivatives.
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
Derivatives. That single word made many young students drop maths as a subject in favour of a totally different educational path. Luckily, derivatives are not limited to the world of mathematics alone. There is a whole financial market that involves trading in derivatives. Remember, this has nothing to do with maths (well, not much anyway).A derivative is a financial contract that derives its value from an underlying asset. This could be stocks, commodities, exchange rates or currencies. Through derivative trading, you can take a measured bet on the future value of an underlying asset. Here are a few steps to guide you in your journey in derivatives.1) Understand how derivatives workIt is often said that knowledge is power. To add to it, knowledge is money too. Trading in derivatives offers great potential for investors to make money. But this is possible only if you are equipped with sound knowledge of how the market functions. Also, be updated with market events. For example, if you are interested in futures trading in the commodities segment, you should keep track of how the prices of metals, oil and other commodities are changing in India and international markets. 2) Find a brokerYou can trade in futures and options through most online brokerages in the market. If you are already trading in stocks, you can get started on your derivatives trading at the same place. If you are a beginner, you need to find a good brokerage firm and open a trading account. Select a broker who offers dedicated support and competitive commission rates. 3) Identify where you wish to tradeAlright, you want to trade in derivatives. But which category are you interested in? There is a huge market open right in front of you. Agriculture, crude oil and metals are some of the categories available in commodities alone. You can also trade in the stock market, forex market and indices. Identify which category interests you to begin trading. 4) Create a trading planOnce you identify a category, you need to do some research to get a better idea about the market. If you already have knowledge about a particular sector, you can start there. For example, if you work in the mining industry, derivative trading in the metals sector is a good idea. After this, you need to create a trading plan to guide you along on your investment journey. Make a list of contracts, time periods and investment goals in a journal. It is quite common for investors to make investment decisions based on emotions once their money is on the line. Instead, what you need is rational thinking. And for this, a trading plan is important. 5) Set up stop loss and profit targetsWhen trading in derivatives, it is always recommended to create a stop loss and profit target. The market can be unpredictable. For example, stock prices may be rising for a certain period of time but all of a sudden, the prices could drop without warning due to some macroeconomic effect. That’s why, even when you are doing well in the market, it is better to create a profit target and exit when you reach the target. Similarly, when the market moves in the opposite direction, good traders identify when to exit the trade and accept losses. By staying in the trade and waiting, you only risk losing a larger sum of money as time passes. 6) Keep track of your positionYour work does not end once you enter into a futures or options contract. You need to keep track of your positions. A single derivatives trade can go on over a period of months. For instance, you may enter a call option to buy a stock at a particular price (say, Rs 50) in the next six months. To go through with the trade, the stock price should be lower or equal to what you expected. If the stock price goes beyond Rs 50, you don’t need to complete the trade. And for that, you need to be aware of how the stock moves regularly. Keep a record of market movements and adjust your positions in a suitable manner.To sum upInvesting in derivatives is not very hard. Anyone can trade in derivatives but to consistently earn good returns is a different matter altogether. You need to know your risk appetite and investment goals and invest accordingly. These steps can help you begin your journey into derivatives. Over time, you can gain more experience and identify your own investment system. Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
The stock market has always been a paradise for traders and investors. They invest their savings in the stock market to make good returns and build a huge corpus over time. Another popular avenue for traders is commodity trading. Commodity trading in India has a long history. In fact, India is among the few countries that started trading in commodities since a very long time. Today commodity trading in India has a significant role and importance. In this article, we will walk you through the commodity trading basics and its related concepts in detail.Let us first learn about the meaning of commodity trading.What is Commodity Trading?A commodity is a group of assets that are important to support our lives like metals, food, energy, etc. When such a commodity can be traded on an exchange and has a price change, they can be purchased and sold just like the stocks, this is termed as commodity trading. In India, there are four classified categories of commodities, they are:• Agriculture – Includes items such as Corn, Coriander, Chana, Castor Seed, Wheat, etc.• Energy – Includes items such as Crude Oil, Natural Gas, etc.• Metals – Includes items such as Copper, Gold, Silver and Platinum• Livestock and Meat – Includes items such as Eggs, Pork, Cattle, etc.Commodity trading is a profession for many traders in India. The trader uses the price fluctuation in the above commodity prices to trade and find opportunities to make money. Now that we know what it is, let us learn where you can invest in commodities in India.Where Can You Invest in Commodities in India?Anyone living in India can trade in commodities through the exchanges. There are six commodity exchanges in total where you can trade in India; they are• National Commodity and Derivatives Exchange – NCDEX• National Multi Commodity Exchange – NMCE• Multi Commodity Exchange – MCX• The Universal Commodity Exchange – UCX• Indian Commodity Exchange – ICEX• Ace Derivatives Exchange – ACEKnowing about the commodity markets in India, let us now learn about investing in the commodity market.How to Invest in the Commodity Market?You can trade in the commodity market through a futures contract. In this type of contract, you enter into an agreement to buy or sell a specific quantity of a commodity at a future price. Every commodity is available for trading through the futures market. The traders, depending upon the predicted price movements take their position. Like for example, if the trader expects the price of a commodity to go up, he would purchase a specific quantity of the commodity and go long. Similarly, if the trader expects the price of the commodity to go down, the trader sells a specific quantity of the commodity and goes short.As you are now aware of the ways through which you can invest in the commodities market, let us now know about the commodity trading time in India.Commodity Trading Time in IndiaThe commodity markets in India is open on all days of the week except Saturdays, Sundays and holidays declared by the exchange. The market timings of the Indian commodity market is as follows:• Agri Commodities: 9 a.m. to 9 p.m.• Bullion, Metals, Crude Oil and Internationally linked Agri Commodities: 9 a.m. to 11:55 p.m.In the year 2018, The Securities and Exchange Board of India (SEBI) extended the commodity trade timing to the above timings in order to deepen the commodity markets as well as to increase the participation of stakeholders such as value chain participants, farmers producers organisations, foreign entities having actual exposure to Indian physical markets, etc. There are many benefits of trading in the commodities market. In this section of the article, we will learn the benefits of commodity trading.Benefits of Commodity Trading• HedgingHedging plays an important role in commodity trading. It protects the traders from price fluctuations as they enter into an agreement at a pre-decided price. • SpeculationSince commodity trading is very popular, traders speculate the future price movements and make heavy profits out of it. • ArbitragingThere are instances when the price of a commodity varies in different markets. The traders take advantage of such a situation by arbitraging. They buy a commodity in one market where the price is low and instantly sell it in another market where the price is high. Individuals wanting to trade in the commodities market often find it difficult to select a commodity broker. In the following section of the article, we will look at how the selection of a broker should be done.How to Select a Broker for Commodity Trading?Selecting the right broker is an important part of commodity trading as your whole experience in the commodity market will depend on it. While selecting any broker, you must look at their credibility and service record. Since your trading experience will depend on the services of a broker, check whether the broker provides the facility of commodity trading online. Another important criterion is the brokerage rates charged by the broker. So, the broker selection must be made after considering all these factors. While selecting the broker, you must ask them to provide a demo of the services provided by them on their trading platform. Test the commodity trading online through the desktop or mobile application and understand the working of the platform. Another important factor that must be considered is the customer support team of the broker. Check how proactive and strong the team is to assist you during any problem or query. Understand with the broker the process of depositing the margin money. Last but not least, you must select the broker who is certified. IndiaNivesh is one such broker who is well known to fulfil all the above criteria and provide its clients with a hassle-free experience. After selecting the right broker for commodity trading, you must open the commodity trading account. In this section of the article, we will learn about the process of opening a commodity trading account.Opening Commodity Trading AccountThe primary requirement for trading in the commodities market is to open a trading or demat account. All you need to do is fill an application form and submit documents like your identity proof, source of income, financial statement, etc. The broker then, depending upon the financial details submitted by the individual, approves or rejects the application. This is an important step as brokers want to be sure that the applicant will be able to meet the debt payments and he does not suffer the losses.After opening a trading account, the next big question for a trader is how much minimum investment is required to trade in commodities. So, let us have a look at the minimum amount required for making the investment in the commodity market.Minimum Amount Required For InvestmentAfter opening the commodity account, you have to deposit an initial amount to start trading in commodities. Initially, you have to deposit at least 5% to 10% of the total contract value. Along with the margin money, the trader must pay a maintenance margin amount to the broker so as to cover the losses that may happen in case of adverse market situations. Let us now read about the importance of trading strategies while trading in commodities.Importance of Trading PlanTrading strategies are very important in commodity trading. With the right trading plan, commodity trading can be very profitable. The commodity trading plan must be developed as per the financial objectives and risk-bearing capability. The trading plan of one trader may not be suitable for another trader. Therefore, the commodity trading plan must be prepared after conducting research and other necessary requirements. The most important part of commodity trading strategy is not to overtrade and always put a stop loss. Furthermore, the trader must put various risk management techniques to maximise his returns and minimise the risk in commodity trading. IndiaNivesh is one of the leading broking firms that provide you all the assistance along with risk management techniques to make commodity trading a profitable venture for you.Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.
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