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DERIVATIVES MARKET PARTICIPANT

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DERIVATIVES …
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OPTIONS CO…

Participants in the derivative markets are of three types depending upon their motive of trading.
These three types are hedgers, speculators & arbitrageurs.

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A. Hedgers
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it to others by paying a price to protect their assets from price fluctuation risk.
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1/28/2021 Derivatives Market Participants
E.g. if a person has 2000 shares of XYZ ltd and the current price of the share is around Rs 200.
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But the person wants to hold the stock for 3 months but he is worried that the price of theSupport
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stock
could fall by that time & also does not wants to sell the stock today because he wants to take the
COURSE benefit of near term price appreciation. SoQuotes
he would in future want to receive at least Rs.190 per
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share & no less at the same time he would like to benefit if the price is above Rs.200 per share by
Derivatives selling the stocks after 3 months. So by paying a predetermined price which is called premium he
buys a derivative product called “option” which allows all the above mentioned requisite features.
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So this way a hedger transfers the risk to a person who wants to take the risk and secures his
RESEARCH assets.
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B. Speculators

There are all types of participants in markets, some with good risk appetite while some with very
low risk appetite. Hedgers are risk averse while speculators are risk takers because they believe
higher the risk higher will be the return.

E.g. Let us consider an hedger had a view that the price of the XYZ Company may fall and eat up
into his profits but a speculator in the derivative market might have the view that the share price of
XYZ Company will go up in 3 months. Hence the speculator will enter into an agreement with the
hedger that he will pay the difference of XYZ shares if the price falls below Rs.190. For this the
hedger has to pay a predetermined price called premium for the option which the speculator is
offering him. Thus the speculator earns the compensation if the stock does not fall & the hedger
receives protection if the stock price falls and can gain profits from the price hike. So speculators
always hunt for higher risk opportunity where they can make higher returns.

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C. Arbitrageurs
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BEGINNERS G… 44
Value of a derivative instrument is decided on the basis of the value of the underlying assets in
spot market. But there are instances when the price of the stock in the cash market is lower or
DERIVATIVES … higher than it should be in the derivatives market. So arbitragers are traders who take the 14
2
advantage of this price difference in the two markets by simultaneously taking a buy position in
one market while a similar amount of sell position in the other market. So an arbitrager makes
profit from such low risk trades.
3 FUTURES CO… E.g. If an arbitrager purchase 100 shares at Rs.2000 per share in cash market and the same
share is quoting at Rs.2001 in derivative markets. Then the arbitrager sells the 100 shares in the
derivative market and makes a profit of Rs.1 per share from this trade.
4
OPTIONS CO…
Why to use derivatives

Derivatives are used to make profits from the volatility in the prices of the stocks, indices,
commodities, currency. Some of the reasons behind derivative trading are Hedging against price
fluctuation, Earn money without physical settlement of underlying asset, Arbitrage trading etc.

a. Hedging or protection against price fluctuation - Derivatives are used to protect the investments
from price fluctuation. Derivatives market has products which help you manage the risk if the price
of the security you want to purchase goes up or if the price of the share which you hold goes
down.

b. Earn money without physical settlement of underline asset - If an investor who has invested in
some stocks which he wants to hold for long term but wants to enjoy the profits from shorter term
price fluctuation can use derivatives. This is because derivative market allows you to conduct
transactions without actually physically selling the shares.

c. Arbitrage trading - If an investor buys at low price in one market and sells high in other market
then that is called arbitrage trading. Here the difference in the price is profit. Derivative market
products allow arbitrage trading.

Derivatives are used to make profits from the volatility in the prices
of the stocks, indices, commodities, currency. Some of the reasons
behind derivative trading are hedging against price fluctuation, earn
money without physical settlement of underlying asset, arbitrage
trading etc.

KEY TAKEAWAYS:
Hedging is strategy to reduce and control risk; this can be done by taking opposite positions in
Cash and Derivatives Market
Speculators believe in high risk and high return philosophy, but more than that they provide much
needed liquidity to the market by entering into buy and sell trades
Arbitrageurs are mostly large organization who can take advantage of arbitrage opportunity as it
needs high speed computing to locate the price difference and trading in large quantity to enable to
make profit

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