To understand how a demat account facilitates trading in derivatives, it’s important to first understand what derivatives are used for, their functions, and the different types of derivatives.
Understanding Derivatives
A derivative is a financial instrument whose value is derived from an underlying asset, such as stocks, bonds, commodities, currencies, or interest rates. Common types of derivatives include futures, options, forwards, and swaps. These instruments allow investors to hedge against risks, speculate on price movements, and manage exposure to various financial markets.
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Investors engage in derivative trading to mitigate risks arising from market volatility across various assets like stocks, bonds, commodities, and currencies. For example, investors opt for equity derivatives to hedge stock-related risks, commodity derivatives for gold price or crude oil volatility, currency derivatives for currency risk management, and interest rate derivatives for interest rate fluctuations.
Among derivative products, options are popular among investors due to their potential for high returns if the trade moves in their favor. Losses in options trading are limited to the premium paid to enter the contract. This high-reward and limited-risk strategy has attracted many investors to participate in options trading in recent years.
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Accessing derivatives markets through a demat account
When investors open a demat account, they unlock access to various financial instruments, including derivatives, enabling them to engage in derivatives trading. Unlike stock trading, derivative trading operates differently.
While investors have the flexibility to choose the number of shares they wish to purchase in the equity market, derivative trading requires investors to transact in lot sizes, which vary for each scrip. Additionally, derivative contracts have specific time frames, typically ranging from one to three months.
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FAQs
Does derivative trading require a lot of experience?
Yes, derivative trading often requires a certain level of experience and understanding of market dynamics due to the complex nature of derivative products. Traders are advised to educate themselves thoroughly and gain practical experience before engaging in derivative trading.
Does trading in derivatives require more margin than trading in stocks?
Yes, derivative trading typically requires higher margins compared to trading in stocks. This is because derivatives are leveraged financial instruments that allow investors to control a larger position with a smaller upfront investment.
Higher margins are necessary to cover potential losses and ensure compliance with margin requirements set by regulatory authorities.
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Why are future prices higher than spot prices?
Future prices are often higher than spot prices due to factors such as the cost of carry, interest rates, storage costs, and market expectations of future price movements.
This phenomenon, known as contango, incentivises investors to sell future contracts at higher prices to compensate for the additional costs associated with holding the underlying asset until the future delivery date.
Can I engage in derivative trading without a demat account?
No, a demat account is essential for engaging in derivative trading in India. A demat account serves as an electronic repository for holding and transferring securities, including derivative contracts. It facilitates seamless settlement and enables investors to track their derivative holdings and transactions conveniently.
Who regulates the derivative market in India?
The derivatives market in India is regulated by the Securities and Exchange Board of India (SEBI), which is the primary regulatory authority overseeing the securities and commodities markets in the country. SEBI formulates rules and regulations governing derivative trading to ensure fair and transparent market practices and protect the interests of investors.
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Published: 28 Mar 2024, 07:16 PM IST