Sunday, June 25, 2017

Derivatives on NSE - Futures and Options

Today I am going to give you a brief about derivatives. So what are these derivatives, why are they called derivatives?

Derivatives can be termed as items which don't have any inherent value within themselves but which derive their value from stocks. These derivatives can be traded in stock market just like regular stocks but the difference lies in the amount of money you get when a derivative moves compared to the underlying stock. The amount of money you can make is really huge if you can just predict the underlying stock movement.

Hindalco Stock

For example consider the stock of Hindalco on NSE. The stock price is currently trading at rupees 190. Now if you buy July future of the stock it might be treating at about 192 rupees, but the value of this feature is entirely dependent on the underlying Hindalco stock. Now consider the underlying Hindalco stock moves from 190 to 192. The July feature of the stock move from 192 to 194. Now consider a person who has who has bought 3500 shares of Hindalco stock when the stock is the trading at Rs. 190 for which he will be spending 3500x190 rupees which is 665000 rupees. Now when the stock moves to 192 rupees, if he sells all the 3500 stocks he has, he will be gaining 3500x2 Rupees which comes around 7000 rupees profit. Now we usually don't have that kind of money, the usual retail traders like us. So what we can instead do is we can buy a future which is the currently trading at the 192 rupees, for which the broker charges you around 20000 rupees if you can assure that you will sell the stock that day itself, then when the stock moves to 194 you can sell the same stock and can get the same 7000 rupees profit but here your investment is only 20000 rupees so if you can just have 20000 rupees in your account you can get a profit of 7000 rupees just like that. That is advantage of derivatives.

Hindalco derivative(29th July Future)

The broker or the bank which you have trading account if you can show them that you will sell the derivative on the same day they will give you an option to buy the derivative stock using leverage(leverage simply means giving you option to buy the derivative as long as you hold 1:20 of the derivative value in your account). That leverage helps you get the derivative of Hindalco which would have cost more than 650000 at 20000 rupees only. What happens if you don't sell the derivative on the same day? so usually at the end of the day, just before the market closes whatever is the price of the derivative, the bank or the brokerage automatically squares off so that their leverage too is protected.

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