Carry forward trade was a system that allowed people to place bets on the future trend in share prices. Eventually, the system was done away with and the market was introduced to modern “derivatives” trading. Stock futures and options or derivatives are used extensively in India for speculation.
Here are five things you need to know about trading in derivatives:
Assets: Derivatives are of two kinds – futures and options. This is the same whether you are trading in derivatives of shares, currencies or commodities. They deal with an agreement to trade at a future date at a certain price. No money is paid while the deal is signed. Futures and options are more or less similar. The only difference between futures & options is that those trading in options are not obligated to actually buy or sell at the said date.
Futures and options derive their value from the underlying asset – trading stocks, indices, commodities like gold, or currency like the dollar. This means, if the price of a stock is $100, you expect it to go up to $110 in a month’s time, then you buy a contract at $100 today and agree to sell it at $110 at the end of the month.
There are many advantages of derivatives trading. Most use it to hedge their losses or safeguarding their investments from fluctuations in the market. Importers and exporters often hedge their currency. Traders also use the secondary market for arbitrage – make more profits.
Derivative instruments are available with registered trading members of stock exchanges like brokerage firms. You will have to fill the Know Your Client (KYC) form if you are a first time investor, along with other forms for purchasing the contract you wish. You are allotted a client identification number, after which you must deposit cash to initiate trade.
Trading is a simple buy and sell process. The only difference is that you will not have to pay the entire sum, but just a margin. For example, if you are buying 100 contracts of futures with a value of 5000, and if the margin is 5%, then you don’t have to pay $5,00,000, but just $25,000. All such transactions are settled at the end of every trading day. Investors are not required to hold any stock of the underlying asset for trading in the derivatives market.More on this topic: