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Derivatives-Beginner's Guide

Why Should I Read this Guide?

If you were one of those people who watched Squid Game after it became all the hype, then fret not, because I was also one. There was one scene in particular that made me consider financial literacy levels and how arcane the topic of derivatives is to the general public.

(In the translated Hindi Version, Sangwoo (Park Hae-soo) says “Mutual Funds” instead of “Futures”, which only exacerbates the efforts of those attempting to spread financial literacy.)

This guide would cover the basic 5 W's and 2 H's of Derivatives:

In later guides, I will also show you how you can apply the knowledge you’ve gained in a practical way and make monetary returns off of it.

and here is a live example of me more than doubling my small investment with a derivative position. Would’ve made more, but greed is a big NO in the market.

With a mere 2% move in Nifty (350+Points) I was able to make 138%+ returns off of my investment. We will discuss about Live Derivatives trade in the next guide.

Derivatives can also give you margin or Leverage. Which means the ability to employ more resources than you have. Leverage is a double edged sword, it has a huge payoff and equally huge loss potential.

Why should you know about Derivatives?

Warren Buffet has called Derivatives the financial weapons of mass destruction.

However, this is only half of the truth.

Derivatives when used in a wrong way can be detrimental to one’s financial health.

Source: CNBC

but, when used rightly and responsibly, can multiply your money in a single day.

Derivatives are powerful financial instruments, and there is no way one does not fall in love with them after learning about them. For anyone interested in knowing how the stock market works, just knowing about equity is no longer enough.

Total turnover and volume (Contracts) of derivatives traded on the exchange is more than 3 times that of equity (Hit a high of over 15 in 2019). They have the potential to multiply your investments by more than a hundred times within seconds, and I think this is reason enough to be interested in learning about this.

Who works in the derivatives market?

Hedging: (keeping your losses capped or limited) is a form of risk transfer. (Farmers, Importers, Exporters, and Commodity Traders)

Speculation: Intraday Traders, who buy and sell these financial instruments on the same day itself, make money by betting on price fluctuations. (Traders, Asset Management Companies and Short-Term Investors)

Arbitrage: Making the best out of market inefficiencies. (Asset Management Companies and High-Frequency Trading Bots)

We will further discuss this in guide 2.

What are Derivatives?