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What is Derivative and How to trade in Derivatives

Posted by : NIFM
14 May, 2013, 5:07 PM
What are Derivatives? The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. A Derivative includes: a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; a contract which derives its value from the prices, or index of prices, of underlying securities; Derivative trading is a type of investment that you can make at the stock exchange. In derivative trading or future trading stocks are bought in lot. In fact future trading is a contract that comes with a time frame that means you have to sell that stock within that stipulated time frame. The number of stocks in a lot varies from stock to stock and price of the lot is determined by the number of stocks in a lot multiplied by the current price of that stock. Advantages Of Derivative Trading – The biggest advantage of derivative trading is that you can buy stocks in future trading by paying only 20% or 30% of the actual price of the stock. So, you are getting more profit at a time without investing more money. In case of derivative trading you can short sell the stocks. That means you can first sell the lot of stock and then buy them back within the stipulated time to honor the contract. In case of an overvalued stock that are sure to fall in near future, you can gain from short selling. This is an option that you can not get in equity trading unless you are doing intraday trading. In future trading the brokerage is usually lower than the equity trading. As you are buying the stocks in a lot the brokerage is calculated not on the unit of the stocks but on the unit of the lot. Disadvantages Of Derivative Trading The disadvantage of the derivative trading is that you have a time frame to complete the selling of the stock. If the stock price does not rise up to the expected level, even then you have to sell off the stocks to complete the contract. Another limitation of derivative trading is that There are some selected stocks in a stock exchange in which you can do derivative trading. Don't take too much exposure Derivative trading is leveraged position. With Rs.50k, you can take an exposure of upto Rs. 2.5lac. But before you buy, make sure you have enough amount in your account as buffer in case the market moves against your expectations.


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