The idea of putting one’s money into an asset to make lucrative returns every day draws more people to the stock markets. These assets usually are equity shares. Inventors invest their money into a company’s shares for the long term and let it compound over time. At the same time, traders try to make quick profits by trading equity shares. However, once one has got the hang of investing and trading equity in the stock markets, they might venture and come across terms like Futures and Options (F&O), currency and commodity.
Like the stock market, other markets exist like the commodity markets and currency markets. The commodity market allows traders to trade raw materials like crude and steel. While the currency market lets different trade currencies. However, trading commodities and currencies are not the same as stocks. One trades in these markets using derivative contracts. However, trading equity derivatives are still the most widely traded derivatives in the derivative market.
A derivative, in simple terms, is a type of financial contract whose value is dependent on an underlying asset. The value of these contracts fluctuates as the underlying asset’s value fluctuates. The underlying asset could be stocks, indices, bonds, currencies and commodities. High volume trading occurs in the derivative markets, and only experienced traders should venture into these markets. Derivatives are also used to build a hedging strategy and for speculation purposes. There are four types of derivatives: Forwards, Futures, Options, and Swaps.
Futures are one of the most popular derivative contracts traded in the derivatives market. A futures contract is an agreement between two parties to purchase and deliver an asset on a future date at a predetermined price. This future date and the predetermined price has the approval of both parties. The buyer is strictly obliged to buy the asset, and the seller must sell the asset on the decided date, called the expiry date, at the decided price.
One cannot buy Futures contracts for a single share of a company. Futures contracts involve a lot or bundle of shares, commodities or currencies. Traders can effectively use it for hedging purposes. However, speculating and trading futures contracts is a very high-risk reward game.
Forward contracts are very similar to futures contracts. However, forward contracts do not trade on the exchanges but trade over-the-counter. Hence there are no regulatory bodies to regulate these contracts. Hence one cannot trade forward contracts using a trading account.
Probably the only type of derivative contract more popular than the futures contract is the option contract. In a way, they are similar to futures contracts, as an options contract is also an agreement between parties. The contract permits a trader to buy or sell an asset on a future date and at a future price. However, the key difference here is that the buyer can exercise the contract.
It simply means that on the future agreed on a date, which is the day the contract will expire, the buyer has the right but is not obliged to deliver the assets. Like futures contracts, options contracts also entail a lot of shares or assets. The trading of option contracts contributes the highest volume in the stock markets. The Nifty 50 and Nifty Bank are two of the most popular option contracts traded in the Indian stock market.
Interest rate swaps are the most common swap contracts. All swap contracts, however, are not traded on the exchange. Like forwards, swaps are also traded over the counter.
Futures and Options (F&O) are the most accessible type of derivative contracts one can access through their trading accounts. Kotak Securities lets one trade futures and options contracts in the equity, commodity and currency segments. Start F&O trading by opening a Demat account with Kotak Securities for free.
Nevertheless, one needs to keep in mind that F&O contracts entail lots and not loosely traded shares or assets. As they entail lots, one should first have sufficient capital before engaging with derivative contracts. The risk involved in trading contracts in the derivatives market is very high compared to trading individual stocks in the cash market.
A small fluctuation in the value of the underlying asset can generate large profits and lead to heavy losses. One should trade in these markets only after holistically comprehending the function of such contracts and the risks involved in trading them.