Strategies for Trading Derivatives

Futures and options contracts are used in derivatives trading between two parties on stock exchanges such as NSE and BSE and commodity exchanges such as MCX, NCDEX, ICEX, etc. Additionally, certain derivative instruments are traded over the counter. A derivatives contract's price depends on an underlying asset, such as a stock, index, currency, commodity or even interest rate. The prices of derivatives are extremely responsive to the underlying asset's price. If the price of the fundamental asset increases, so may the price of the derivative and vice versa. However, even though these strategies have stood the test of time and perform in all market conditions, there is no holy grail method for making money through derivatives trading. It is always prudent to backtest the derivatives trading strategies outlined here to identify the one that best fits your needs. Futures Trading Strategies Futures traders transact in either the long (buy) or short (sell) direction. Here are the four most common strategies for trading futures: - Extended Trades Long trades are a prevalent type of futures trading. When you purchase futures, you are confident that the underlying asset's price will rise before the contract expires. The further the price rises above the price you and the vendor agreed upon (strike price), the greater your potential profit. - Inverse Trades Short transactions involve the sale of futures. When you sell a futures contract, you anticipate that the underlying asset's price will decline before the contract expires. Generally, short trades are considered riskier than long trades, as losses can be substantial if the price moves in the opposite direction. - Calendar Spread for Bulls In this futures trading strategy, the trader purchases and sells futures contracts on a single underlying asset with distinct expiration dates. The trader typically goes long on options with a short-term expiration and short on options with a long-term expiration. To increase their profit margin, investors employing this strategy anticipate the spread to widen in benefit of long positions. - Calendar Spread for Bears The opposite of the bull calendar spread is the bear calendar spread. The speculator goes short on the short-term contract and long on the long-term contract in this futures trading strategy. Investors who prefer this strategy anticipate broadening the spread in favor of short positions to increase their profits. Options Trading Techniques There are two categories of options: call and put. A trader has the right to purchase the fundamental asset at a predetermined price if he or she purchases the call option. In contrast, the put option grants the speculator the right to sell the underlying asset at a future predetermined price. Here are the most prevalent options trading strategies employed by the traders. - Buy Call Long call is one of the most popular options for investment vehicles. You can execute this trade if you are confident that the underlying asset and the corresponding strike price will rise before the expiration of the contract. Remember that time is the enemy of choice. The quicker the fundamental asset price rises above the strike price, the quicker your profits will accrue. However, you may incur a loss if the price increases on the ultimate date of contract expiration. - Buy Put When you purchase a put, you anticipate that the underlying asset will decline in the future or before the expiration of the contract. Profit is generated if the fundamental asset falls below the strike price. However, if the asset's price rises, your premium (the amount you paid to purchase the put) may become null and void. - Covered Call Methodology In this options trading strategy, you purchase a fundamental asset on the spot market and then sell a call option on the same asset. This strategy is utilized by investors with a neutral to favorable outlook. Regarding the risk-reward ratio, the reward is limited, whereas the potential losses are unlimited. Moreover, volatility may create additional difficulties for a trader who relies on this strategy to generate profits. - Married Put Method In this strategy, an investor purchases a put option on securities he or she already owns or intends to purchase. This strategy is employed by investors generally favorable on stock to mitigate the impact of a price decline. Conclusion Now that you are familiar with the best strategies for trading derivatives, put your knowledge to the test by opening a demat and online trading account. To make informed decisions, you must familiarise yourself with the best trading strategies through reading and studying.