Derivatives And Financial Market Trading

By Author: alexander
Total Articles: 10
Comment this article

What are derivatives?

Derivatives are a popular financial agreement that obtains their value from the underlying security. You can trade several instruments such as currencies, indices, stocks, commodities with this instrument. It may even include the rate of interest and exchange rates.

With derivatives, you aim to maximise your investment gains by betting on the underlying security's future value. Thus, they obtain their value from an underlying security. It is the reason why they are named so.

History of the derivatives market

Derivatives are old financial market instruments. The traces of the first futures agreement can be found from the second millennium BC in Mesopotamia. However, the derivatives were not popularly used until the year 1970. The advancement in technology sparked the accelerated expansion of the derivatives market. This popularity has reached so far that we cannot imagine the modern financial market without derivatives.

Benefits of trading derivatives

Derivatives have a significant impact on the modern financial market ...
... as they offer sundry advantages to traders. The advantages include:

1) Hedging against risk

As the value of futures and options contracts is associated with the underlying security value, the aggregates are mainly employed for hedging risks. For instance, a trader may buy a derivative agreement whose price moves in the reverse direction to the price of security the trader holds. It is how the derivative agreement may compensate for losses in the underlying secret.

2) Price determination of underlying security

Derivatives are usually employed for estimating the price of the underlying security. For instance, to approximate the commodity's price, you can use the futures' spot value.

3) Efficiency of market

It is regarded that derivatives surge the potential of financial markets. By using future and options agreements, you can duplicate the payoff of the security. Hence, the value of the related derivative and the underlying security value tends to be in equipoise to eliminate arbitrage trading opportunities.

4) Admittance to unavailable markets or assets

Derivatives help in trading those markets and assets which are otherwise unavailable for trading. Using interest rate swaps, a firm may get a more likely interest rate related to interest rates obtainable from direct borrowing.

Disadvantages of Derivatives

Despite the benefits offered by derivatives to the financial market trading, these financial instruments also come with some critical setbacks. These setbacks resulted in several unfortunate results at the time of the Global Financial Crisis, the year 2007-2008. The accelerated devaluation of mortgages backed securities, and credit-default swaps resulted in the institution's collapse and financial securities worldwide.

1) High risk

The extremely high volatility of the derivative instruments opens them to massive losses. The complicated design of the agreement makes the valuation primarily tricky and sometimes impossible. Hence, they carry a high inherent financial risk.

2) Speculative features

Analysts regard derivatives as an instrument of speculation. Because of the unpredictable behaviour of derivatives and precarious nature, unreasonable speculation may result in massive losses.

How to trade derivatives

To trade derivatives, you require a legitimate brokerage firm offering an online trading account. After opening a trading account, you can start trading. The steps for opening a trading account are:

1) Get yourself registered with the broker by signing up. It may require a name, last name, country, email id and phone number.
2) Enter the OTP number received on your email id or phone number.
3) Once you enter OTP, the website will redirect you to the documentation page. The documents include address proof, identity proof, banking and financial statements not older than six months.
4) Select the market and asset you wish to trade and deposit the required amount for the same.
5) You can now start trading.

If you are thinking about the top brokerage firm offering excellent services at an affordable rate, there is no other option than