Bored with investments and trading in conventional stocks and bonds? If you are looking to trade outside the box of equity, derivatives trading may pay off. You may have had to open a demat account to start your stock investment journey, and it's no surprise that you did. Stocks are, by far, the most popular go-to avenues for trading and investment today. Nonetheless, if you have earned well through stocks, you may want to invest more capital in other investment instruments.
Profitable opportunities can occur with derivatives which offer diversification of financial portfolios and hedges to combat volatility in other assets. In case you are wondering whether derivatives are a good choice for you, you need to grasp certain concepts before you decide.
What are derivatives?
Financial contracts which derive value from any underlying asset (stocks, currency, bonds, etc.), between buyers and sellers, are known as derivatives. In the common parlance of the markets, they are primarily known as futures and options contracts. In these derivatives contracts, buyers agree to buy an underlying asset and sellers agree to sell them. Derivatives are good because they are effective in hedging positions and traders can often speculate on the direction of movement of underlying assets in question. There is a certain degree of leverage when you trade in derivatives. When you open a demat account to trade in equity, you may have to do some groundwork before you enter the markets. Similarly, knowing how derivatives function can give you an edge in trading wisely.
How Derivatives Function to Benefit You
Any changes in prices of underlying assets like bonds, stocks, currencies, commodities, etc. decide the value of any derivatives contracts. Options contracts, futures contracts, swaps and forwards are all examples of derivatives commonly traded with. The types of derivatives you decide to choose will depend on your investment goals, the underlying asset, your potential for risk, etc. Just as you make a plan when you wish to invest in any financial vehicle, like an upcoming IPO, before going into a derivatives contract, you must do your homework. The market of derivatives is a good choice for many investors, but notably, it is influenced by the date of expiry in any contract, fluctuations in interest rates, and factors of demand and supply.
Considerations Before Trading
It is easy to open a demat account and trade in stocks today. You can do this at any online portal, through a reputable brokerage. It is just as simple to trade in derivatives, but you must do some work beforehand. Here are some key considerations to determine whether derivative markets can be good places for you to invest:
- In derivatives contracts, investors can set prices to agree to buy or sell underlying assets by a certain expiry date.
- Derivatives provide a hedge to combat adverse shifts in prices and rates in the markets.
- Derivatives may prove worthy to mitigate your risks in trading in underlying assets.
- Derivatives may be bought on a margin, meaning that traders can borrow money in order to enter contracts.
Think Before You Invest
It's always a good idea to do some deep thinking before you take on any investment. You must remember that a derivative has no intrinsic value per se. It gets its value from the underlying asset. Therefore, such contracts may often be vulnerable to risk and market sentiment. As you know when you open a demat account to invest in equity, there are risks involved, so there are with derivatives as well. However, if you plan your strategy to invest, by doing research into underlying assets, just as you would if you invested in any upcoming IPO, derivatives can be a good way to diversify your portfolio and see gains.
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