Derivatives have no inherent value. They rather derive their value from an underlying asset. These assets can be anything from Debt to Equities toSecurities to Currencies to Indices toCommodities. There are two significant derivatives: Futures & Options. The only difference between the two is that Options give you the right but not the obligation to carry out the agreement. UnderFutures, you enter a deal and need to honour it.
How to trade in them?
While Futures provides an opportunity to deliver the underlying asset, most people use them for speculating or hedging. However, to trade, speculate, or hedge, you must understand how Future and Option Trading works. Once you gain clarity, you need to select a trading platform and open a Trading Account. You can also avail of a broker’s service where you place orders online or via phone.
Besides, focus on the followingessential steps before trading with these Derivatives:
Objective
Every time you decide to invest a large sum of money, you should know what you want to achieve. Would you secure your investment portfolio by hedging in the derivatives market? Do you want to undertake risk, earn profits, and make strong bets (speculating)? Do you wish to utilise low-risk market imperfections by buying in one market and selling it at a higher price in the other one (arbitraging)? Ask these questions before trading.
Type of derivative
Once the objective is clear, decide whether you want to trade Futures, Swaps, Options, or Forwards.
Risk-reward payoff
Thisis the reward you earn for every rupee you risk. While making the trade, consider the ratio to compare the expected investment returns and decide if the rewards are worth the risk.
Consider premium and margin amounts
Derivatives Futures and Options require you to pay premiums and margin amounts. The premium depends on the underlying asset’s price, volatility, and expiry, among other factors. Meanwhile, the margin amount is a deposit before you initiate trading, and you cannot withdraw them until the trade gets settled. These fees can affect your returns, so you need to be mindful while trading.
Formulate a strategy
With some knowledge of Futures and Options Trading, curate a plan. While formulating the strategies, be aware of how much cash you have handy, the margin requirements, how much premium to pay, the derivative price, and its underlying asset.
You could stay invested until the contract expiry date, i.e.,the last Thursday of every month or settle the contract before expiry and make a profit.
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