What are the Risks associated with trading in Derivatives?

Investors must understand that investment in derivatives has an element of risk and is generally not an appropriate avenue for someone of limited resources/ limited investment and / or trading experience and low risk tolerance. An investor should therefore carefully consider whether such trading is suitable for  him or her in the light of his or her fi nancial condition. An investor must accept that there can be no guarantee of profi ts or no exception from losses while executing orders for purchase and / or sale of derivative contracts, Investors who trade in derivatives at the Exchange are advised to carefully read the Model Risk Disclosure Document and the details contained therein. This document is given by the broker to his clients and must be read, the implications understood and signed by the investor. The document clearly states the risks associated with trading in derivatives and advises investors to bear utmost caution before entering into the markets.

Example 1.

An investor purchased 100 Nifty Futures @ Rs. 4200 on June 10. Expiry date is June 26.  Total Investment : Rs. 4,20,000. Initial Margin paid : Rs. 42,000  On June 26, suppose, Nifty index closes at 3,800.

Loss to the investor (4200 – 3780) X 100 = Rs. 42,000  The entire initial investment (i.e. Rs. 42,000) is lost by the investor.

Example 2.

An investor purchased 100 ABC Ltd. Futures @ Rs. 2500 on June 10. Expiry date is June 26.  Total Investment : Rs. 2,50,000. Initial Margin paid : Rs. 37,500  On June 26, suppose, ABC Ltd. shares close at Rs. 2000.  Loss to the investor (2500 – 2000) X 100 = Rs. 50,000

Example 3.

An investor buys 100 Nifty call options at a strike price of Rs. 4000 on June 15. Nifty index is at 4050. Premium paid = Rs. 10,000 (@Rs. 100 per call X 100 calls).  Expiry date of the contract is June 26  On June 26, Nifty index closes at 3900.  The call will expire worthless and the investor losses the entire Rs. 10,000 paid as premium.

Example 4.

An investor buys 100 ABC Ltd. put options at a strike price of Rs. 400 on June 15. ABC Ltd. share price is at 380. Premium paid = Rs. 5,000 (@Rs. 50 per put X 100 calls).  Expiry date of the contract is June 26  On June 26, ABC Ltd. shares close at Rs. 410.  The put will expire worthless and the investor losses the entire Rs. 5,000 paid as premium.

 

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