With the recommendations from L.C. Gupta committee, derivative trading in India was introduced more than a decade back. Initially, it was started for Indices which later on was initiated in stocks, commodities, currencies. As of now, all these markets offer ample liquidity and are acting as strong tool for different types of participants of markets. Recently, we saw the launch of derivatives in Interest rates (Interest rate futures) also which will enable participants to guard against the volatility in interest rates.
For the people, who are new to this subject, derivatives are the instruments that derive its prices from an underling like stocks, commodities, etc. Derivatives instruments traded in the exchanges are of following types
Futures – which trades for the contract with pre specified contract specifications and to be delivered at future date.
Options – which gives the buyer a right but not the obligation to deliver the contract of pre defined specification at a future date.
Though the prices in a derivative contract are meant for the delivery however the most of the contract are cash settled where only the difference between buying/selling price and current price is paid/received. Therefore,, it is also called as contract of differences.
Being a leveraged contract, it provide you with better returns and as such become more riskier. Here anyone may loose even beyond the capital put in for trading. Exchange specified margins are in the range of 5% to 30% generally in various asset classes, which if considered as capital, might be lost in entirety when market moves beyond this levels and you need to put in more money to maintain your position. A good trader keeps an amount separate towards such settlement of price difference (called as MTM, Mark to Market). A such, he stays strong on his position and does not get bothered with small fluctuations. Important to note that in equity derivatives, their are no circuit filter in exchange which means trading in a day will not stop even when price will fall beyond 20%.
Before entering a market, you need to ascertain that what kind of participant you are, a hedger (who comes to market to cover risk), a speculator (who is willing to take risk of loosing capital but actually wants to make money by judging direction of market), or a arbitrageur (who wish to make money, though small but without taking significant risk). A common mistake people make is to change their style as per their situation in the market. Often hedger becomes speculators and speculators becomes hedgers in losses. As such, deviates from their fundamental requirements and gets into the trap of greed and fear.
If you are a speculator and is comfortable with the risks associated with derivatives, then select your scrips. Start only with Index or the stocks/commodities which you been tracking in spot market. This is the place where you will be aware of basic nature of the scrip and all you need is to use derivatives as a tool to better your returns.
In derivatives you may buy a future, sell a future, buy a call option, sell a call option, buy a put option or sell a put option. Apart from these many more strategies can be developed using the combinations of above. However, do not try to complicate your trading unless you understand them well. You may use excel by linking it your trading software and make a quick glance view on complex strategies.
Remember derivatives are a very nice tool only if you know how to use else it might hurt you. A proper training on the same before taking off will make a lot of sense. Now a days even online lessons are available or alternatively you may attend workshops from experienced professionals.
Happy trading!!!
