How Does a Demat Account Facilitate the Trading of Derivatives?

When you open a Demat trading account, you may know that a Demat account is a holding facility to store your securities in an electronic format.

In a Demat account, all your securities can be held securely in one place. This helps you to monitor your financial portfolio regularly and plan your investments conveniently. 

Additionally, a Demat account linked to a trading account helps investors undertake share market transactions (buy, sell, and transfer stock) very smoothly. To understand how a Demat account enables you to trade in derivatives, you need to understand the concept of derivatives first. 

Derivatives Explained

Stocks are not the only financial instruments or securities you can invest in when you open a Demat trading account. Derivatives are common investment instruments and are gaining popularity as they offer ways to hedge risk while investing. Let’s try to understand what derivatives are.

A derivative is a financial instrument that works in the form of a contract agreed upon by two parties. This is a financial instrument (in the form of a contract between two parties) whose value is derived from an underlying asset. 

Underlying assets that could be part of a derivatives contract include stocks, bonds, currencies, commodities, etc. Typically, derivatives are in the form of futures, options, swaps, and forwards.

With such financial instruments, investors hedge against risks, manage exposure to different financial markets, and speculate on movements in prices. 

Why Derivatives are Becoming Popular

The process of online trading has become seamless and more and more investors are looking for different investment options online. Investors are drawn to derivative trading as they are able to mitigate risks generated from market volatility across different assets like bonds, stocks, commodities, and currencies. 

For instance, investors may select equity derivatives to hedge risks related to shares. Furthermore, they may opt for commodity derivatives to combat crude oil or gold price volatility. 

Among the derivative products available for investment today, options prove popular choices as they offer the potential for substantial returns in case trades go in favourable directions. The losses incurred (if any) in options are limited to the premiums paid by investors when they enter such contracts. So, options provide attractive features of limited risks and potentially high rewards. 

What is an Options Derivative Contract?

If you open a Demat account, you can partake in an options derivative contract, one of the most popular derivative contracts today. In such a contract, there are two parties involved, the one that buys the contract and the one that sells the contract. 

The contract has a value that is derived from an underlying asset that it represents, like a stock or a commodity. 

In options contracts, which have a specific date of expiry, the buyer or the seller has the right to buy or sell the contract by the date of expiry but is under no obligation to do so. Either party can opt out of the contract, but they have to pay a premium which is mandatory when they enter the contract/agreement. 

Your Demat Account and Derivatives Market Access

Investors open a Demat trading account when they wish to invest in financial securities. A Demat account unlocks easy access to derivatives investment, but differently compared to direct investment in other securities, like say, stocks. 

For instance, in direct investment or trading in stocks, stocks may be bought, held in a Demat account, and sold for potential profits at a date in the future. 

For derivatives investment, investors may have the flexibility in selecting the quantity of shares they want to buy in the equity market, but they are required to buy them in lot sizes. 

These lot sizes are different and vary from scrip to scrip. What’s more, derivative contracts are bound by particular timeframes, and these may range from a month to three months. 

Derivatives Contracts and Demat Accounts

If you wish to engage in derivatives investing in India, it is essential to open a Demat trading account. This is an account that not only holds securities electronically but also transfers them and helps you electronically transact securities. 

Derivatives contracts can be a good way to manage risks in trading and investing and your Demat account may help you invest in them with potentially fruitful results. 

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