To invest in the stock markets, you first need to understand the basics of it. You might have listened to Shares, Derivatives, Options, etc. several times. Ever wondered what they are and why so many different kinds of securities are available to invest in? Let’s find out.
Shares
Shares are units of ownership stake in a financial asset or a corporation that provide for proportionate distribution in profits, if any are declared, as a dividend. The two main classes of shares are common shares and preferred/preference shares. Physical paper stock certificates have been replaced with the electronic recording of stock shares.
Derivatives
A derivative is a financial security having a value that is reliant on or derived from an underlying asset or group of assets. It is a contract between two or more parties based on the asset or assets. Fluctuations in the underlying asset determine its price. The most general underlying assets are stocks, bonds, commodities, interest rates market indexes and currencies.
Derivatives can either be transacted on an exchange or over-the-counter (OTC). OTC derivatives constitute the standardised proportion of total derivatives and are unregulated. On the other hand, derivatives traded on exchanges are standardised. OTC derivatives generally have a greater risk for the counterparty than standardised derivatives.
Futures
Futures are financial contracts that obligate the buyer to purchase an asset or/and oblige the seller to sell an asset, like a financial instrument or a physical commodity, at a predetermined future date and price. A futures contract details the quality and quantity of the asset underlying; they are standardised to facilitate their trading on a futures exchange. Some futures contracts might need physical delivery of the asset, while others can just be settled in cash.
Options
Options are the contracts that grant a right, but not an obligation to buy or sell the underlying asset on or before a certain date, at a set price. Options are classified as a derivative security, as the price of an Option is linked intrinsically to the price of something else. Specifically, The right to buy the underlying asset is called a “Call Option”, and the right to sell the asset is called a “Put Option”. People somewhat familiar with derivatives may confuse this definition with what a future or forward contract does. However, the futures or forwards present both the right as well as the obligation to buy or sell at a certain point in the future. For eg, somebody who shorts a futures contract for horses is obliged to deliver physical horses to the buyer unless they close out their positions before expiration. An Options contract does not carry the same obligation, which is exactly why it is called an “Option.”
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Visit the 5Paisa website for more information.
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