Do you know What is Derivative Market? It is a kind of instrument that is traded on the Stock Exchange. What exactly it is that we will see further. This article is all about “Derivative Market – Meaning, Types, Participants, and Differences”
A derivative is a kind of instrument that derives its value from the underlying asset. This market was initiated in India in 2000 and since then it is gaining pace in the stock market significantly. You know that derivatives are highly leveraged instruments that increase the risk and rewards.
These underlying assets can be of any sort like shares, debentures, currency, and many more. Let’s start with knowing about the derivative markets first.
What is a Derivative Market?
Meaning Derivative Market: Derivative instruments can be traded on the stock exchange or can be traded on the over-the-counter (OTC). Exchange simply defines the establishment of the stock exchange where all the securities are traded and follow the rules and regulations by the SEBI.
Over-the-Counter (OTC) market defines the dealer-oriented market of securities, which is an unorganized market and where the trading happens using the mode of phone calls, emails, etc. A derivative that is traded in the stock exchange is standardized and follows the regulations.
Where the OTC market in which the derivative instruments get dealt is a sort of customized market and lack regulation in it and with that, it also has higher counter-party risk. These financial instruments help in making a profit by making bet on the future value of the underlying asset.
- It also provides an opportunity for arbitrage.
- It also hedges the securities.
- In this, you transfer the risk to another.
Why do investors find lucrative in derivative contracts?
There is more advantage of dealing in the derivative contracts apart from making the profits.
- It gives an arbitrage advantage.
- It can be also used for speculation.
- It also provides protection against market volatility.
Participants in Derivative Market
Following all are the derivative market participants:
- Hedgers
- Margin Traders
- Speculators
- Arbitrageurs
Different Types of Derivative Contracts
1. Options
- Options are the agreement between the buyer and the seller.
- In which the buyer gives the right but not the obligation to buy or sell a certain asset at a later date on an agreed price.
2. Futures
- These are standardized contracts and are traded on the stock exchange.
- This is an agreement between the two parties for a particular contract at a specified time and on an agreed price beforehand.
3. Forwards
- These are the customized contracts and are traded on the Over the Counter (OTC) Market.
- This is also an agreement between the parties for a certain contract at a specified time and on an agreed price.
4. Swaps
- Swaps are also a type of derivative contract where the parties exchanges the cash flows at a certain interest rate.
- Interest rates swaps are mostly used instruments of the derivative market and swaps are traded on the over-the-counter (OTC) Market.
We had already discussed the types of derivatives market. Now, let’s have some discussion on the types of futures, as they are traded on the exchange-traded funds.
Types of Futures Contracts
1. Stock Indexes Futures
2. Stock Futures
3. Commodity Futures
4. Currency Futures
5. Interest Rate Futures
Now let us see some types of margin requirements in derivative trading:
Types of Margins Requirements
a) Initial Margin
b) Maintenance Margin
c) Variation Margin
Difference Between Cash Market and Derivative Market
Let us find out the difference between Cash Market and Derivative Markets:
Cash Market
- In cash markets, you can purchase single shares also.
- In Cash Market, tangible assets are traded and are used for investment purposes.
- Cash Markets need for the customer to open the trading account.
- In the cash market, the dividend is entitled to the owner of the shares.
Derivatives Market
- In the derivatives markets, which can be futures or options you need to purchase minimum lots that are fixed.
- In the derivatives market, the assets can be tangible or intangible for trading and it is used for hedging, speculation, or for the purpose of arbitrage.
- While in the derivative market the customer needs to open the future trading account from the derivative dealer.
- In derivative markets, the holders are not entitled to dividends.
Conclusion
Under this article, we managed to inform you about the basics of the derivatives market and its types and how it gets traded in the market. Hope that you like this article on “Derivative Market Meaning, Types of Derivatives Contracts, Participants in the Derivative Market and Difference of cash market and derivative market” if you like the blog then you can also share it with your mates for the same.
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