Can Investing Equity Derivatives Help You Untap Potential Profits?

equity and derivatives services in Vadodara

Are you here because you want to learn to invest in financial instruments like equity derivatives? It is a great way to diversify your financial portfolio. Before getting familiar with what equity derivatives are, let us first get to know what each of the terms means individually. 

Equity or equity securities are shares that investors can buy and sell. For example, the purchase of shares of any listed company in the stock market. So, equity represents the shared ownership of a company via stocks and profit sharing.

Now, coming to derivatives. Derivatives are financial instruments that serve as contracts between two or more parties. Derivatives allow you to buy and sell the assets in future. Anticipations and estimations on the future value of the asset help the investors to make gains, on the same basis. The value of derivatives depends on an underlying asset, index, or group of assets.

The combination of these two concepts gives rise to Equity Derivatives. Let’s know how this financial instrument works and what its perks are.

What are Equity Derivatives?

Equity derivatives are an active form of trading on stock exchange platforms. In 2022, the National Stock Exchange (NSE) got recognized as the largest Global Derivatives Market consecutively for the 4th time.

The equity shares that the investor owns can act as an underlying asset, that gives value to the derivatives. Shares, bonds, Commodities, and securities are the kinds of underlying assets. The performance of companies and share market movements affect the value of underlying assets. In much simpler terms, it is the individual stock or leading stock indices like Nifty or Bank Nifty from which it derives its value. 

If you prefer to benefit from short-term gains equity derivates are one of the investment options that you can consider. When you buy derivatives you purchase the performance of the underlying securities. It does not mean that you are taking ownership of the company or equity.

Benefits of Trading in Equity Derivatives

Benefits of trading in equity derivatives

Traders invest in equity derivatives for speculating purposes and risk management of their portfolios. They manage the risk through technical and fundamental analysis. To know more about the benefits of trading in equity derivatives, read along.

Risk Management

Equity acts as a tool that converts the risk related to the underlying assets. The risks shift in equity derivatives. Individuals averse to risk become heavy risk-takers in the share market. 

Hedging

Investing in equity derivatives helps you reduce the risks that occur due to adverse market fluctuations. It helps investors take an offsetting position. 

Arbitrage

Selling of asset in one share market and buying it in the other, to profit from the price difference. You may wonder how the profit is earned. It is because of the difference in the value of assets in different equity derivatives markets.

Margin Trading

In margin trading, you have to pay only a marginal amount. Not the entire amount. Margin trading allows you to maintain high outstanding. When the predictions are accurate, then the profits earned are on the higher side of growth. 

Risks Associated with Equity Derivatives

The stock market is the ball game for either risk-averse investors or risk-loving investors, depending on the market conditions. Like any other financial instrument, equity derivatives come with its own share of risks.

Market Risk

Like any other investment, market risk is associated with equity derivatives too. The market can lose value because of dire economic conditions, recessions, and fluctuations in interest rates. This is why, traders need to have extensive knowledge about the market to gauge the potential of an investment.

Volatility

Regular fluctuations in the value of underlying assets result in volatility risks in the market. Due to such fluctuations, the risk of volatility is high in equity derivatives. As these depend on the fluctuations in the stock market.

Counterparty Risk

The counterparty or other parties can become financially incapable of the commitment due to various reasons. Credit risk, litigation risk, settlement risk, etc. come under counterparty risks. These risks arise when the counterparty doesn’t keep their end of the bargain, in the contract.

Who Should Invest in Equity Derivatives?

Traders who consider equity and derivatives as one of smart investing options should invest in equity derivatives. One needs to have an eye for technical detail while making predictions. 

Equity derivatives can be a good option for investors who understand the market volatility risk, the overall market risk, and counterparty risk. Investors who are good at risk management, want to diversify their portfolio, and understand hedging against price fluctuations, arbitrage and margin trading can go ahead with investing in equity derivatives.

4 Types of Equity Derivatives

Let’s look at the 4 types of derivatives, that allow you to trade through contracts in equity derivatives.

Futures

In equity derivatives, the futures binds the contract between two parties. There is an agreement between the buyer and the seller, where both the buyer and the seller agree to buy and sell the underlying asset at a contract price.

Parties agree on a prespecified date in the future, at a predetermined price to sell the futures contract. The buyer and seller remain obligated to the contract.

Options

Options also allow you to buy and sell the shares at the specified preset prices. This price is called the strike price. It is different from the futures contract in a way that the buyer is not obligated.

Hence, the buyer may or may not hold the terms of the agreement. Whereas, the seller is obliged to sell the shares. The losses are limited, and the gains are high, compared to futures contracts

Warrants

In warrants, the holder can buy the underlying securities in future at a specified date. So, this equity derivative type gives the holder the right to buy, without being obligated to do so. It is a sub-variety of the ‘options’ contract. Warrants are a kind of options contract that has a longer term.

Typically, these are contracts traded over the counter.

Swaps

There is an exchange of equity stocks in this kind of equity derivative, as the name suggests. There is an exchange or a swap of two different equity stocks between two parties. Exchange can be of currencies, fixed interests, floating interests, equity-related returns, etc.

At a specified rate, there is an exchange of cash flow on a future date

FAQ about Equity and Derivatives

What is a focused equity fund?

A focused equity fund is a kind of mutual fund. Here, one can invest in a small number of stocks and gain potential returns. Best-performing stocks are picked up for delivering high returns. At a time, one can invest in 30 shares maximum, according to the SEBI guidelines. HDFC Focused 30 Fund, SBI Focused Equity Fund and Nippon India Focused Equity Fund are some of the top-performing Focused Equity Funds in India.

What is Equity Delivery?

Equity delivery is when you buy the shares and hold them in your Demat account and wait for the right time to sell. In delivery-based trading unlike intraday, you don’t have to buy and sell the shares on the same day. In equity delivery, you own the stocks that you purchase outright and wait till it brings you to a profitable stage. To get started with equity trading, you can call us at 9825107677. With the help of our financial consultants in Vadodara at Value4Money, you can also open a demat account. Start equity trading with personalized guidance provided by Value4Money’s financial advisors.

What are sweat equity shares?

Sweat equity shares are shared and presented by the Company to its Directors or Permanent Employees (Inside or outside India). Such shares are given at a discount other than cash, to make available rights in the nature of intellectual property or value additions. It is a kind of reward that the company gives to the employees to recognize their efforts in fulfilling the objectives of the company.

What is an equity swap?

An equity swap is a swap or an exchange of future cash flows between two parties during a specified period. It enables each party to expand and diversify their portfolio for a time period along with the hold on the original assets. It is based on the returns of equity indices. They are a part of over-the-counter trading. In equity swaps, big institutions hedge positions or specific assets.

How are equity derivatives regulated?

Equity derivatives are regulated under SCR(A), which is the Securities Contract Regulation Act framed in 1956 and includes securities derived from financial debt instruments, shares, loans, and risk instruments for differences. The stock market in India is reformed and regulated on a regular basis. In July 2023, SEBI announced the plan to link the amount of equity derivatives of retail investors to their overall wealth, to mitigate risks.

How to trade in equity derivatives?

To trade in equity derivatives in India, investing in Futures contracts and Options contracts is a good option, provided you are well-versed in its investment strategies. Most importantly, as discussed in the blog, you should know the basics of equity derivatives trading and its functioning in the share market. You also need to open a demat account to start trading. The financial experts at Value4Money in Vadodara can provide you with personalised guidance and ease you with opening a Demat account for you to start trading.

Connect with us at 9825107677 to open an account and trade in equity derivatives.
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