Futures, options and derivatives: Watch any movie about the financial markets and you are bound to hear these words. Traders in good looking suits rush around the trading floor spouting these terms at the top of their voices. It all sounds rather important and complicated. But what are these words exactly? And how do you invest in derivatives? Let’s find out.
What are derivatives?
Derivatives are financial contracts between investors. They derive their value from another asset such as stocks, bonds or other commodities. That’s why they are known as ‘derivatives’. Based on the change in price of the underlying asset, the price of the derivative is determined.
How to trade in derivatives?
Future contracts and options are two of the most common types of derivatives. Here is how you can invest or trade in these avenues.
As the name suggests, a futures contract is a contract between two investors to conduct the sale of an asset for a specific price and a pre-determined point of time in the future.
Here is how a futures contract takes place. Imagine there are two investors: Santosh and Meera.
Santosh has 100 shares of company X. The value of each share at the moment is Rs 50.
Santosh wants to sell the shares after six months. However, he fears that the market could take a downturn by then. He wants to ensure that he gets a good return on the sale of his stocks.
He tells his broker to find a buyer for his shares.
Meera is an investor who wishes to buy the shares of company X. She is confident that the market is poised for a boom in six months. She decides to enter a futures contract with Santosh.
As per the contract, she is willing to buy 100 shares of company X at Rs 80 per share after six months.
In reality, two things could happen: the market could go up as Meera expects or go down as Santosh expects.
Imagine the market goes up. The stock price of company X rises to Rs 120 per share.
This means that Meera earns a profit of Rs 50/share.
As for Santosh, it doesn’t really matter whether the market goes up or down because he has already booked his profits at Rs 30 per share.
Imagine the market goes down. Let’s assume the prices of company X falls to Rs 20 per share.
This means Meera makes a loss of Rs 30 per share.
In order to avoid such losses, Meera could instruct her broker to create a stop loss. For example, if she creates a stop loss at Rs 40, the broker immediately sells her shares when the stock hits the specified price.
In this way, Meera can ensure that her losses are minimized.
An option is like a futures contract. Here too, two investors enter into an agreement to trade a security at a particular price on a pre-determined date in the future. But in the case of options, the buyer or seller is not obligated to go through with the transaction. He has the ‘option’ to conduct the transaction. This allows the investor to gain a leveraged position on the stock while at the same time he can avoid the risk of a total purchase. Options are commonly used by traders to hedge their positions in the market.
Derivatives offer investors the opportunity to hedge their bets in the market and maximize their returns. If you have the appetite for some risk and if you possess an understanding of the Indian markets, investing through derivatives can be largely beneficial. And the next time you hear someone talking about derivatives on the TV, you know exactly what they are talking about.
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
How to invest in debt
Debt: the word itself conjures up the image of a moneylender standing on the doorstep waiting for his money. However, debt is not always bad. You may have heard of people ‘being in debt’ but what about ‘investing in debt’? When you make a debt investment, you loan the money to a corporate or the government. In return, you receive returns in the form of interest. If you are interested in tax-efficient steady returns and safety of principal, then debt funds are ideal for you.Here are five different types of funds that you can include in your portfolio: 1) BondsBonds are debt securities issued by government entities and corporate houses. These entities raise money for financial purposes, which include funding investments and enhanced cash flow. When you purchase bonds as investment, you receive a regular income through interest payments. At the end of the maturity period, you receive the original investment made. There are different types of bonds such as government bonds, corporate bonds, high-yield bonds, international bonds and so on. 2) Public provident fundThe Public Provident Fund, or the PPF, has been a popular debt-oriented investment for for the past many decades. This scheme is backed by the government of India and offers a high degree of protection on the principal as well as interest. As an investor, you are guaranteed a fixed return each year. The current rate of interest on PPF is fixed at 7.6% per annum . PPF is a 15-year scheme. At the time of maturity, you have the option to extend the plan indefinitely in blocks of five years. The investments you make under PPF are eligible for a tax deduction of Rs 1.5 lakh under Section 80C of the Income Tax Act. In addition, the interest you earn is not taxable. 3) National Saving CertificateNational Saving Certificate (NSC) is a savings bond offered by the Indian government. It is one of the safest investment avenues in the country. It is available at all post offices and investors can invest for up to 10 years in this scheme. Currently, the interest rate on NSC investments is 7.8% per annum*. It is popularly used as a tax-saving instrument by government employees, salaried individuals and businessmen. Further benefits include:a) Tax deductions are applicable under Section 80C of the IT Act. b) No upper limit on how much you can investc) You can get loans from banks by offering certificates as collateral 4) Gilt fundsGilt funds are mutual funds that allow you to invest in government bonds and securities. These funds carry zero default risk and they are considered to be very safe. These funds invest in debt that is of low risk and high quality. And while the returns can be moderate, the invested capital is safeguarded against risk. That’s why these funds are suitable for beginners or those who are risk averse. 5) Debt mutual fundsDebt mutual funds are different from gilt funds as they invest in a mix of securities such as corporate bonds, money market instruments, treasury bills and government securities. Compared to gilt funds, the risk is higher but they offer high returns too. If you are interested in earning a steady income during uncertain interest rate movements, you can invest in fixed maturity plans (FMPs). These are close ended debt funds with a fixed maturity date. ConclusionMost people think of equities when it comes to investments. However, investments in debt can be a great way to balance your portfolio and to earn steady returns. Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.*https://www.indiapost.gov.in/Financial/Pages/Content/NSC.aspx
How to invest in gold and other commodities
Did you know that you could invest in some of the most common everyday items we use in our daily life? Be it food items, gold, silver, oil or gas, we can trade in such items. This is all possible thanks to commodity investing.What is commodity investing?Raw materials that are consumed directly or used to make other products are known as commodities.This includes:Commodity investing is the process in which different investors (individual people, banks, and corporations) buy and sell these commodities in order to earn high returns. How to invest in gold and other commodities:1) Physical ownershipThe simplest way to invest in a commodity is to buy the physical good directly. For example, you can invest in gold by buying 10 gold coins. When the price increases, you can sell the commodity and convert your investment into cash. This method of investing comes with its own set of challenges. For instance, you have to figure out where to store the commodity. You want to ensure that your gold is in a safe place. And when it comes to soft commodities such as corn, wheat or coffee beans, issues such as spoilage and insurance come into the picture. 2) Exchange traded funds (ETFs)ETFs are funds that trade like stocks. You can purchase ETFs of commodities and trade them in the market in order to earn profits based on change in price movements. Investment in commodity ETFs is a good way to diversify your portfolio. The best part is that unlike physical commodities, it is very easy to buy and sell ETFs. You can also hold these investments in your regular investment accounts. However, make sure that you thoroughly review the commodity ETF before investing in order to get the best returns. 3) Stocks of companiesAnother way to invest in gold or other commodities is to buy shares of companies that manufacture these commodities. For example, you can buy shares in a gold mining company to gain indirect exposure to gold. Similarly, there are many companies in the mining, energy and agriculture sector. Investing in these companies is a good way to gain exposure to these commodities. 4) Future contractsYou can buy or sell a commodity in the futures market. This means you can buy a fixed quantity of the item at a fixed later date. For instance, you can take a futures contract for coffee in order to protect yourself against rising prices of coffee. In case the price of coffee does rise after the specific period, the value of your investment would increase too. But if the price of coffee decreases, your future contract value decreases. Another way to invest is to enter into an agreement with a buyer to sell the commodity at a fixed price at a fixed later date. Futures contract is an easy way to invest in specific commodities without actually having to own the commodity directly.ConclusionInvestment in commodity ETFs is a good way to diversify your portfolio. Understand how the different avenues work before investing. This is to ensure that your investment is protected and you can earn good returns. Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
Are you Investment ready?
*All fields are mandatory