If you are looking forward to spreading your investments and trades – what would be some of the options that you would choose? What are you thinking? The list is long, isn’t it? Let’s look at one of these tools in detail; let’s understand derivatives.

What are Derivatives?

Derivatives are financial contracts whose value is decided by the value of the underlying asset or group of assets. Stocks, bonds, currencies, commodities, and market indexes are some of the most regularly used assets.

The underlying assets’ value will change in response to market conditions. The main idea behind getting into derivative contracts is to benefit by betting on the future value of the underlying asset.

Consider the possibility that the market price of an equity share may rise or fall. You could lose money if the stock price falls. In this case, you could enter a derivative contract to profit by putting in a correct bet.

Alternatively, you might simply protect yourself from losses in the spot market where the stock is traded.

The concept of what is derivatives should be making sense to you now. Next, let’s see how these financial derivatives actually work.

How Do Financial Derivatives Work?

Trading in the derivatives markets is similar to trading in the cash component of the stock market. To trade derivatives, you will need a trading account.

The derivatives market is traded on exchanges and over the counter (OTC).

Exchange-Traded Derivatives: Exchange-traded derivatives are contracts that take place through a broker. Futures and options are derivative transactions that are traded on exchanges. When you buy a stock option, you are buying the option rather than the securities.
Over-the-Counter Derivatives: Over-the-counter derivative contracts are those that take place directly between two parties. Over-the-counter contracts include forwards and swaps. As a result, these contracts are tailored to the needs of both parties to the contract.
Additionally, financial derivative contracts do not come without risk. They are accompanied by the danger of market volatility. As a result, trading in the derivatives market without suitable hedging methods is dangerous.

So, what kind of derivatives are actually out there?

Types of Financial Derivatives in the Market

Majorly, there are four kinds of derivatives. Let’s know them in detail:

1) Futures

Futures are a sort of derivatives contract in which the buyer and seller agree on the amount and price of an asset. The agreement specifies the amount, price, and date of the transaction. The buyer and seller are bound to fulfill their duties upon entering into the contract, regardless of the asset’s current market worth. Futures contracts are widely used for risk management and speculation. Yet, the main goal is to protect the asset’s price against volatility.

You can take advantage of margins by purchasing a futures contract. A margin requirement is a minimum amount required to trade futures on an exchange. The lesser the margin, the bigger the leverage.

2) Options

In India, options contracts are the third type of derivative transaction. Options contracts vary from future and format contracts in that there is no requirement to discharge the contract on a certain date. Contracts for options grant the right but not the obligation to purchase or even sell the underlying instrument. Options contracts have two options:

a) Call Option

b) Put Option

While joining the contracts, the buyer has the full right to purchase an

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Types of Financial Derivatives Demystified: A Comprehensive Guide to Options, Futures, Swaps, and More

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