Trading is one of the most fascinating businesses in the whole world as market movements impact each and every one of us in some or the other way.
You might be running up a business and realized that the economic, currency and market movements had an impact on your business activities or the companies you deal with, so you got a kick from your within to learn to deal with these dynamic market fluctuations or you might be working for a company and got rewarded with ESOPs and are wondering what should you do with it? Should you really vest it or should you hold or sell? This pushes you to learn what stocks and markets are all about or you might have heard someone talking about stock markets, commodities or mutual funds and are wondering how you too can put your money into a real work or you might be an aspiring trader planning to dedicate your life to learn about the markets so as to make a consistent living out of trading.
We have distributed this whole discussion in different sections with follow up articles to help you learn every bits and pieces of trading business and markets.
This section starts with the very basics of market, i.e. what the markets are all about? What are different assets classes & instruments available for trading?
What are stocks?
Stocks represent the ownership of the company. So, if you own some stocks of say Tata Motors than you own some right over the earning of the company and if company grows and makes some profit than you had the right over to those profits in proportion to the stocks you own.
Currently, there are approximately 1600 companies listed on the National Stock Exchange (NSE) with a total market capitalization of Rs. 6,059,258 Crores.
What is an index?
A stock market index is created by selecting a group of stocks that are representative of the whole market or a specified sector or segment of the market.
CNX Nifty Index (Nifty) which is an average of top 50 stocks that covers 21 sectors of the Indian economy and offers exposure to the Indian market in one efficient portfolio
CNX Bank Index (BankNifty) which is a index comprised of 12 most liquid and large capitalized Indian banking stocks listed on the National Stock Exchange (NSE). It is a broad-based benchmark that is diversified across public and private banks that captures the performance of Indian Banks in India.
What does the price and movement in Stocks or Index imply?
The current prevailing price of any index or stocks represents what the market is ready to pay for it. This price is not only dependent on how the company is performing right now but more on how well they are going to perform in the future i.e., its growth potential, capacity to effect its sales, profits and cost. So, any movement in the index or stocks is derived by the demand and supply in the market which in turn is driven by the future expectations of the market participants. If the market participants see good future prospects of the economy, specific industry or the stock then they will be willing to pay a premium price so the price rises or when they foresee some negatives, then price declines as more sellers are there in the market than the buyers.
What are derivatives?
Derivatives are leveraged products whose value is derived from an underlying asset like Equity, Commodity, Forex, Currency, etc. Derivatives can be categorized into two sets: – Futures & Options
What are Future Contracts?
Future contracts are legal enforceable agreements to buy or sell an asset on a specific date or during a specific month on a regulated futures exchange. A futures contract is standardized according to quality, quantity, delivery, time and place. The only remaining variable is price, which is discovered through an auction-like process that occurs on the exchange electronic trading platform.
Commodity Futures such as Gold Future, Silver Future, Wheat Future, or Potato Future etc
Equity Index futures such as Nifty Futures, BankNifty Futures etc
Stock Futures such as Reliance Futures, Tata Motors Futures etc
Currency futures such as Rupee-Dollar, Rupee-Pound etc
Who trade Futures?
Hedgers and Speculators are the two categories of traders who participate in the futures market where hedgers use the futures market to manage their exposure to the price risk while on the other hand speculator accepts that risk to take the benefit of the favorable price movement. The market would not be possible without the participation of speculators as they provide immense liquidity in the markets and in turn help the hedgers to enter and exit the futures markets in an efficient manner.
So, the ultimate objective of hedging is to reduce or limit the risk of future price movement than to predict the price movement to make profits while speculators are the one who do not have any position in the underlying asset like hedgers rather they are trading in the market to take the benefit of the price movements.
Read Article : Getting Started with Trading – Who trades the market?
Why trade Futures?
The leverage available in futures trading allows you to utilize your capital more efficiently. Leverage on futures contracts is created through the use of span margin, often referred to as margin. This is an amount of money deposited by both the buyer and seller of a futures contract and the seller of an option contract to ensure their performance of the contract terms and meet their obligations.
Read Article : Trading Futures Market
Options Contract
An option contract is the right, but not the obligation, to buy or sell a particular futures contract at a specific price on or before certain expiration date. There are two types of options: call options and put options. Each offers an opportunity to take advantage of futures price moves without actually having a futures position.
Call Option
A call option is an agreement between you and the seller where he agrees to sell you a specific stock or asset at a fixed price on or before an expiration date.
Suppose, a man agrees to sell you a house for Rs. 50 Lacs (Fixed Price) and asks you to pay a privilege or premium amount of 1 Lac (Premium) to extends you a time period of 1 month (Expiration Date) to pay him. If at the end or before one month expiration, you are able to find a buyer for that house for say 60 Lacs then you exercise your option to buy the house for Rs. 50 Lacs and make a profit of 9 Lacs (60 – 50 -1). But on the other hand, if you are unable to find a buyer for that house for more than 51 Lacs, then you lose 1 Lacs and do not need to buy that house and let your right to buy expires.
Same applies with buying call options on index or stocks. For example, if you are expecting Reliance Industries stock price to raise from its current price of Rs. 900 then you buy an April Reliance 900 call option for Rs. 5. Suppose if, before the expiration of April Contract, the price advanced to Rs. 940 then the price of that 900 April call option will rise to 40+ and you can make a profit of Rs. 35.
On the other hand, if the price falls to say 850, then you let your right to buy expires and you had your limited loss of Rs. 5
Put Option
A put option is an agreement between you and the buyer where you agree to sell him a specific stock or asset at a fixed price on or before the expiration date. For example, if you are expecting Reliance Industries stock price to fall from its current price of Rs. 900 then you buy an April Reliance 900 put option for Rs. 5. Suppose if, before the expiration of April Contract, the price decline to Rs. 850 then the price of that 900 April put option will rise to 50+ and you can make a profit of Rs. 45.
KNOWLEDGE IS POWER!
