What are derivatives?
A derivative is an instrument which derives its value from the underlying asset. The asset can be equity, a currency or even an index. Derivatives are usually in the form of a contract, where the buyer is under an obligation to buy or seller is under an obligation to sell the underlying asset at a specified price on a specified date in the future.
Why invest in derivatives?
Derivatives have traditionally been used by businesses to hedge against different types of risks, and have been in existence for decades. With well-planned strategies based on a thorough study of the markets, individual investors and traders can earn handsome returns through derivatives trading.
Investment in derivatives has the following advantages:-
• Hedging against risk: Derivatives are used for hedging against risk in price fluctuations of the underlying asset. Since the buy (or sell) price at delivery is specified in advance, the buyer/seller can protect his investment from deviation in price trend.
• Lower costs: The investor needs to pay only for the contract, which is usually much less than the price of the underlying asset, thus offering a benefit of lower costs.
• Leverage: Trading in derivatives involves use of leverage through margin that is maintained with the broker. Hence, lesser cash is required to be paid at the time of trade.