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Understanding The Concept Of Currency Derivative Trading

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Contracts or financial instruments whose values are determined by the spot market price are called derivatives. These are also known as the variable conditions to the market like the bond, stock or a currency. The underlying market conditions can be the currency exchange rates, the market indexes, the interest rates, the market securities or the equity prices. The transactions are also of different types. They may be traded in the form of options, futures, swaps, collars, caps, etc. Trading in derivatives in India usually takes place in a separate part of an already existing stock exchange called the individual derivative exchange.

Understanding The Concept Of Currency Derivative Trading

The National Stock Exchange allows both options and futures to be traded as derivative instruments.

  • Futures

In this type of trading, the two parties involved enter into an agreement where they may sell or buy a particular asset at a particular time in the future at a price as specified in the agreement. These future transactions are generally made in cash. The commodities market is where these kinds of future trading are done. The contracts for these future transactions are denominated in a currency agreed to by both parties involved.

  • Options

This is a special type of contract. The options contract gives the investor the option to either sell or buys a particular commodity at a predetermined time in the future at the price as specified in the contract. Now there are two types of options contracts. The calls options contract empowers the buyer with the right to purchase a predetermined quantity of a given commodity at a price as set in the contract. The purchase can happen either before the specified date or on it. The puts options contract like the calls allows the buyers to sell a commodity under the same conditions.

Advantages of trading in derivatives:

Leverage

The procedure of using financial instruments or borrowing capital like margins so that the potential return on an investment may be increased is called leverage. While trading in currency derivatives, a person has to only pay a percentage of the margin value instead of paying the full traded value.

Hedging

An investment made with the sole purpose of reducing the price movement risk of an asset is called hedging. This method can effectively protect one’s foreign exchange exposure. Potential losses can also be hedged. Hedging is generally done when the holder of a particular currency estimates its depreciation. This helps to cut back on the losses that may be incurred.

Arbitrage

The procedure of selling or purchasing a particular commodity in two or more different markets at the same interval of times is called arbitrage. This helps by enabling the person to take advantage of the price difference in the different markets for the same commodity.

Speculation

Making risky investments in the market over the fluctuation in prices of a particular commodity in order to make a medium or short term profits is called speculation. This practice helps to make quick profits.

In conclusion, trading in derivatives is easy and often the risk is low as compared to other forms of investment.

Author’s Bio

The writer is an avid blogger and a stock market expert with the website www.vikson.in.