The presence of derivative transactions in forex companies in India is increasing in the stock market:-When you hear about derivative transactions in forex companies in India, you may think it seems complicated. Still, in reality, it is a transaction that many investors are already familiar with. We will introduce in an easy-to-understand manner the mechanism and types of derivative transactions that are gaining attention and their advantages and disadvantages.
What is a derivative transaction in forex companies in India?
- “Derivatives” are financial products derived from the original products such as stocks, bonds, interest rates, foreign exchange, currencies, gold, and crude oil. And “derivative trading” refers to trading financial products derived from underlying assets such as stocks. Derivatives are called financial derivatives.
- Derivative trading in forex companies in India is characterized by avoiding the risk of price fluctuations by deciding the future trading price and trading with leverage that allows trading larger than the actual input amount.
- The word “derivative” gives the impression that it is hard to stick to. However, in reality, it is a transaction that is already familiar to those who invest in stocks. You may have heard the terms stock index futures such as Nikkei 225 futures and TOPIX futures, but these are derivative transactions.
- Stock index futures are transactions that significantly impact the whereabouts of stock prices. I think you often see reports such as “The Nikkei average has plummeted and soared, led by futures.” Checking derivative products such as Nikkei Average Futures is very important for understanding the whereabouts of stock prices. It is essential for investors to know derivative transactions, even if they do not.
- About the derivative market
- The derivatives market in forex companies in India is the market where derivative transactions are conducted. There are two types of transactions: exchange and over-the-counter transactions (OTC transactions). The Nikkei Average Futures I mentioned earlier are listed on the Osaka Exchange, so they are traded on the exchange. In this way, exchange transactions refer to transactions in which listed products (stocks, options, etc.) are bought and sold on financial instruments exchanges and commodity exchanges.
- On the other hand, over-the-counter transactions (OTC transactions) are transactions between sellers and buyers. A transaction directly conducted by a securities company or bank and an investor.
- Foreign exchange margin trading (FX trading), which is famous as FX, also corresponds to derivative trading, and most of them are bought and sold as over-the-counter trading. Forex also has exchange trading (Click 365) bought and sold on the Tokyo Financial Exchange.
Types of derivative transactions
Derivatives trading in forex companies in India can be broadly divided into three categories: futures trading, options trading, and swap trading. Let’s look at each one.
- Futures trading may be the most familiar derivative trading for equity investors, such as Nikkei Average Futures. Futures trading is a transaction that promises to buy or sell a specific product at a predetermined price in the future or at a price decided at the time of contract. Transactions are conducted through the exchange.
- For example, I will briefly explain the mechanism with Nikkei Average Futures. Suppose you want to trade using the Nikkei 225 futures when the Nikkei Stock Average is 27,000 yen. If you think that the Nikkei Stock Average will rise by the set deadline, you will “buy” the Nikkei 225 futures.
- If the Nikkei Stock Average has risen to, for example, 28,000 yen on the deadline, investors who “buy” can profit from the rise. On the other hand, if the price drops to 26,000 yen, you will have to pay the difference to the securities company. The settlement method in this way to settle the contrast of the “price of the settlement point in time” and “price at the time it was promised at the time of contract” net settlement will be.
- You can also enter Nikkei 225 futures from “sold” in anticipation of the index falling by the deadline. In that case, the idea of profit and loss is the opposite of “buying.”
- There are various types of futures, such as “bond futures” for bonds, “financial futures” for financial products and interest rates, and “currency futures” for exchange rates, as well as stock index futures.
- The transaction form is the same as the futures transaction. There is a ” forward transaction (forward transaction) ” in which the repayment method is not the difference settlement but the cash settlement. The difference from futures trading is that forward trading is a bilateral transaction (= over-the-counter transaction) in which the seller and the buyer trade one-on-one, and it is possible to individually determine the “price,” “quantity,” and “payment method.”
- An option transaction in forex companies in India is to purchase the “right” to buy or sell a product at a specific price on a predetermined date in the future. It is “rights” to buy and sell. Buy the “right” by paying the option fee, a commission.
- A typical example is the Nikkei 225 option, linked to the Nikkei Stock Average. To briefly explain the image, for example, after half a year, buy the “right” to accept the Nikkei Stock Average for 27,000 yen for 500 yen. The Nikkei Stock Average rises six months later. For example, if you exercise the “right” to buy when it reaches 30,000 yen, you will profit (30,000 yen-27,000 yen-500 yen = 2500 yen). On the other hand, when the stock price drops to 25,000 yen, you can waive your rights because you will lose money.
- The option means “choice.” The person who bought the “right” can choose to trade. If you decide that you will lose if you exercise your rights on the due date and trade, you can waive your rights. In that case, the loss will be only the option fee originally purchased (500 yen in the above example). On the other hand, the right seller cannot waive the right.
- Options trading includes “currency options” such as “stock index options” for stock indexes and “bond options” for bonds.
- Swap transactions in forex companies in India are transactions in which exchange cash flows such as interest rates and currencies under pre-promised conditions. Swap means “exchange.” Swap transactions also allow you to exchange payment obligations of different nature, such as exchanging floating and fixed interest rates. It is used as a risk hedge for rising and falling interest rates.
- The principal is not exchanged; only the interest rate portion is exchanged with the other party. Since it is an over-the-counter transaction, the transaction conditions and period are decided in advance with the trading partner. It is used by financial institutions as a hedging instrument for interest rate fluctuation risk, used for interest rate hedging of corporate borrowings, and incorporated into personal financial products.
Advantages of derivative transactions
- Derivatives trading has many benefits. The first is that you can leverage and trade more than you have. By putting in a certain amount of margin, you can trade larger than your funds. Therefore, you can aim for an enormous profit, but on the other hand, there is a risk that the loss is significant.
- Second, you can avoid the risk of market fluctuations. In futures trading, you can trade not only by “buying” but also by “selling.” When the stock market falls, risk can be avoided by “selling” futures trading. If you use options trading well, you can profit when the market price plummets.
- It’s also attractive that you don’t have to pay all your principal. In futures trading, you can buy and sell with a certain amount of margin, and the settlement is a contract for difference. Only interest rates can be paid in swap transactions.
Disadvantages of derivative transactions
- Derivatives trading also has its disadvantages. Derivative trading is more complicated than physical trading because it deals with future buying, selling, and rights. When opening an account at a securities company, it is necessary to open a regular stock account and an account for derivatives, which requires a certain level of investment experience and knowledge. Also, with the recent development of financial engineering, more complicated products have been developed and may be difficult to understand. When you start a derivative transaction, you need to know how the product works.
- In addition, since the settlement date is set in advance for derivative transactions, it is necessary to settle on the due date regardless of the amount of loss. It is also important to note that you can make significant losses because it is a leveraged transaction that allows you to make significant transactions with a small amount of money.