In today’s market, if you think that shares and bonds are your only option for playing the market, well, you are far from the truth.
You may be thinking that if this is about the commodity market, then, I may as well shut up and move on. Here the underlying assumption, as held by most of us, is: derivative markets are for extremely risk-loving people who have a deep and experienced understanding of the derivative class as an investment category.
So, are we going to leave an entire class of investment just slip away just because we think we don’t know or are we going to do something about it? If you are interested in investing in the market at all, then why fight shy without a little try?
• Step 1: what is “commodity trading”?
If you have ever placed a bet on anything, you’ve already participated in a commodity trading. Let me explain: you betted with your brother that if India wins the Border-Gavaskar Test series, you’re going get Rs. 100 from him and if otherwise, you’re going to pay him the same. Here, your money is basically a commodity or derivative product, based on the performance of the underlying security (the test series), you are chancing upon a profit.
Financially speaking, a derivative is a product whose price depends upon the performance of another product. If the share performs well, its derivative will earn you profit, depending upon your bet.Online commodity trading has made this whole process a hassle-free way to invest.
• Step 2: speculation
Suppose you have reasons to believe that the star fast bowler of Australia will not bowl as much in the final test as he was supposed to. And your brother does not think like this. With this assumption you placed the bet as if India wins, you’re winning a hundred. And that’s what happens. This is called speculation.
In derivatives’ terms, suppose you think the price of AA share will go down very soon. You buy 100 shares and make a contact with another investor that you will sell him the shares at today’s market price by tomorrow. And the prices fall, by the contract, you win some handsome profit: speculation well done!
• Step 3: Hedging
Suppose you’re a florist. If the price of dozen roses, currently Rs. 120, goes up to Rs. 144, you will have to face lose. However, the less the price goes the more profit you’ll earn.
Conversely, for your supplier, if the price goes bellow Rs. 96, he’ll go out of business and the more the price, the better for him.
Now you and your supplier make a contract that no matter how far the price goes up or down, you’re going to purchase at the range of Rs. 108-132. This way, you both secure some profit and therefore ‘hedge’ or protect yourself from loses. When you do this through a derivative contract, it’s called financial hedging.
There are many derivative products available in the market. Just with a clear idea regarding how the underlying asset is behaving, you can make some handsome profit.