What is Derivatives in stock market, how it is different from equity shares?

Derivatives are contract between two parties to buy an underlying asset at specific price and specific quantity at future date, whose contract value is derived by the underlying asset.

Difference is Derivative market deals with future prices where as equity market deals with the spot prices.

Derivatives were actually introduced to reduce/mitigate 'Risk' in a portfolio or a security [called as Underlying Asset].

In the days without derivatives, investors would just purchase securities and hold them in their portfolio. But they were left clueless when price of the securities came crashing down. With derivatives, one can ‘hedge’ the risk.

Derivatives are of two types: 1. Futures. 2. Options.

Let me take a scenario. I purchased 1000 quantity of a security 3 months back. Now I feel price of the security is going to come crashing down in the next month. But I do not want to sell the security from my portfolio as my ‘long term’ view is still bullish.  So, now I hedge the risk by selling ‘futures’ or by following some ‘option’ strategies.

More on the derivatives- here!

For example you BUY 200 shares of a specific equity stock. You are hoping stock price would increase.

If you want to safeguard your position (to prevent from loss, in case your assumption is wrong), What you can do?

You cannot sell 200 equity shares as opposite to prevent your loss. This will obviously nullify your 200 shares in demat account (what you have purchased earlier) and will exit your trades of BUY and SELL.

This is where Derivatives comes in. Derivatives like Futures will have similar price as like your equity stock.

You can sell/short 200 shares of the same equity stock’s futures, in opposite.

When market rise, your Equity Stocks will be in profit and your Derivative Future will be in loss.

When market falls, your Equity Stocks will be in loss and your Derivative Future will be in profits.

In this way, you can hedge or nullify your losses.

If you talk about options, its a whole lot wider perspective. So not touching that now.