Hedging is an act, whereby an investor seeks to protect a position or anticipated position in the spot market. It is done by using an opposite position in derivatives.
This means that if you have a buy position, you have to create a sell position and vice-versa.
The parties who perform hedging are known as hedgers.
They want to reduce or limit the impact of such movements, which, if not covered, would incur a loss. • The hedger achieves protection against changing prices by purchasing or selling futures contracts of the same type and quantity or by exercising options.
The derivative market offers products that allow you to hedge yourself against a fall in the price of shares that you possess.
It also offers products that protect you from a rise in the price of shares that you plan to purchase and that’s only the tip of the iceberg.
There are a wide variety of products available and strategies that can be constructed which allow you to pass on your risk to other market traders, who are more than willing to take it on.
Speculators
In the Indian markets, there are two types of speculators -day traders and the position traders.
A day trader tries to take advantage of intra day fluctuations and the up and down movement in prices.
They do not leave any position open at the end of the day, i.e., they do not have any overnight exposure to the markets.
On the other hand, position traders greatly rely on news, tips and technical analysis (the science of predicting trends and prices) and take a longer view, say a month, in order to realize better profits.
In the Indian markets, there are two types of speculators -day traders and the position traders.
A day trader tries to take advantage of intra day fluctuations and the up and down movement in prices.
They do not leave any position open at the end of the day, i.e., they do not have any overnight exposure to the markets.
On the other hand, position traders greatly rely on news, tips and technical analysis (the science of predicting trends and prices) and take a longer view, say a month, in order to realize better profits.
Arbitrageurs
Life is not perfect and capital markets have their share of imperfections too.
Sometimes the price of a stock in the cash market is lower or higher than it should be, in comparison to its price in the derivatives market.
Arbitrageurs exploit these imperfections and inefficiencies to their advantage.
Arbitrage trade is a low risk trade where a simultaneous purchase of securities is done in one market and a corresponding sale is carried out in another market.
These are done when the same securities are being quoted at different prices in two markets.
XYZ Ltd., suppose the cash market price is Rs 1000 per share, it may be quoting at Rs 1010 in the futures market.
An arbitrageur would purchase 100 shares of XYZ Ltd. at Rs 1000 in the cash market and simultaneously, sell 100 shares at Rs 1010 per share in the futures market, thereby gaining Rs 10 per share on the day that the futures contract expires.
