• HDFC securities
• 22 Jun 2023
• Knowledge Centre

Derivatives derive their values from the underlying assets or a benchmark. These are financial contracts between two or more parties that are traded over-the-counter or through an exchange. The National Stock Exchange of India (NSE) stood 4^th in terms of the number of trades in cash equities according to a report by the World Federation of Exchanges for 2021. It also emerged as the world’s largest derivates exchange for three consecutive years as of 2021, in terms of the number of traded contracts which is quite a moment of pride.

Derivates are used by investors to speculate on an asset’s price movement without needing to own the underlying assets. Others use them to hedge against a position or use leverage. There are numerous types of derivates available on equities, bonds and currencies. It is important to learn a few best practices to trade them like an expert and make your trading experience more effective. Read on.

Requisite Margin Amount

You are required to deposit a portion of the value of the contract you intend to enter into. SEBI has mandated 20% of the transaction volume be deposited by traders. Certain brokerage firms might need 30%-40% to be deposited as the margin amount. This amount can alter as and when the price of the underlying instrument falls or rises. So, make sure to keep some extra money in your account to be on the safe side.

Margin Maintenance

Stocks and their contracts should be selected on the basis of the funds in your trading account. Keep in mind the margin requirements, price of other contracts and price of the underlying shares in mind as well. The maintenance margin is the amount that must be present in the trading account at any given time. If you fail to do so, your position may be automatically liquidated. Talk to experts who can brief you on how margin works to enhance capital efficiencies.

Research the Market

There are three contract months at a time in the NSE F&O sector. This comes with an expiry date that is typically the last Thursday of the month. You must exit before this date to avoid a case of auto settle. This can further help in minimise losses and protect your capital. Keep your eye on the market to stay informed of price movements to exit the contract at the right time.

Define Financial Risks

Regardless of the types of derivatives you pick, set limits to the risks that you take. Now, create steps that can help ensure you stay within this limit. Put a cap on position sizes and have a system handy that can send precise reports regarding the risks being taken for better monitoring. Avoid crossing the limits even if the markets appear tempting. Letting emotions like fear and greed guide your decisions can prove disastrous.

 

Diversification

The primary purpose of diversification is to mitigate risks. You may also be able to obtain better returns with a diversified portfolio than a non-diversified one. It is also quite possible to receive the same returns for lesser risks, limit portfolio fluctuations and minimise the impact of market volatility. Diversification is a fantastic way to balance and spread investments. In simple terms, try not to put all your eggs in one basket.

OTC derivatives let you enjoy features that are tailored to fit your needs. Get in touch with a reliable brokerage firm for expert advice. You may also learn about derivates examples like futures contracts, options contracts and credit default swaps to pick the best one.