Stocks vs Derivatives – Understand the Basic Difference

Financial markets all around the globe trade in a wide range of financial instruments that vary in their nature and functionality in various ways. Investors get the opportunity to trade in multiple instruments according to their goals and risk appetite and build a diversified portfolio. Stocks and derivatives form an integral part of the stock market ecosystem, making it essential for you to know about them. In this article we will understand what are stocks, what are derivatives and compare stocks vs derivatives.

What are stocks?

Stocks, also called equity, are the most common capital market security. The stock owner, i.e., the stockholder, gets a fraction of ownership in the issuing company in proportion to the stocks purchased. Share trading of the listed companies takes place on the stock exchanges such as NSE, BSE, S&P 500 through stock trading app.

What are derivatives?

Derivatives are valid financial contracts between two or more parties that derive their value from the underlying asset, benchmark, or group of assets. The common underlying financial instruments include shares, bonds, commodities, market indexes, and currencies. Two popular derivatives are futures and options. A futures contract can be based on an index or stock, whereas an options contract can be of two types- call or put option. Derivatives can be easily traded online on options trading app.

Stocks vs Derivatives – The Exact Difference

1. Risk involved

Stock trading is well regulated and transparent as compared to F&O Trading. Stock trading is comparatively less risky as the risks are contained within the corporations to which shares are connected. Derivatives trading is riskier as it heavily relies on the underlying asset fluctuations and contracts made for a predetermined date.

However, derivatives tend to have an opportunity for higher returns than stocks. This also entails a very hefty risk of making losses. Investors should heavily consider their risk appetite before dwelling in F&O Trading.

2. Key Nature

In Stock Trading, you have to pay the entire amount to buy stocks, and the stocks you buy are actual stocks in your Demat account. However, in the case of F&O Trading, you can buy and sell by paying the margin money, and the stocks don’t get transferred; instead, it is buying and selling of the derivatives contract.

You can buy any quantity of stocks you want in the stock market. A derivatives market allows you to buy or sell only in specified lot sizes.

3. Yield and Volatility

Stocks give returns in the form of profits due to selling after increased share price and dividends paid by the company or ongoing annual yield. F&O Trading has the scope of giving high yields if the contract’s predetermined price plays in the investor’s favor.

Derivatives are more volatile than stocks, but their high volatility can also lead to greater profits depending on the contract. At the same time, it elevates the possibility of high losses for the investor.

4. Time Period

Future and options contracts are usually for 1,2 or 3 months which is predetermined. On the other hand, stocks can be bought and sold whenever you want. Stock trading is divided broadly in two types i.e Delivery and Intraday.

To wrap up

Now that you understand the fundamental difference between stocks vs derivatives, you can consider investing in both stocks and derivatives after setting your financial goals, understanding your risk appetite, and doing further research to suit your needs.

You can also read about Value Investing vs Intraday Trading – The Exact Difference or What is Intraday Trading.

Want to start trading in the stock market? Here are some more interesting articles on trading that will give you walk you through the basics of buying & selling shares, the building of strategies in online stock trading & much more.

Happy Trading 📈

Disclaimer: This blog is not to be construed as investment advice. Trading and investing in the securities market carries risk. Please do your own due diligence or consult a trained financial professional before investing.

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