Pocketful

Category: Trading

  • Margin Trading vs Short Selling – Key Differences

    Margin Trading vs Short Selling – Key Differences

    What if you could borrow money to buy more stocks and multiply your gains? Or imagine selling shares you don’t even own, betting their price will fall so you can buy them back cheaper later. Yes, the Indian financial markets offer you these opportunities and these intriguing strategies are known as margin trading and short selling. While both offer unique opportunities to potentially boost your returns (or losses), they operate in fundamentally different ways. 

    Today, we are going to explore the difference between margin trading and short selling. We will look at what it means to be buying on margin vs short selling, and understand the unique ways these powerful tools work. 

    What is Margin Trading?

    Margin trading is the practice of buying securities with borrowed funds from a broker, allowing investors to trade larger positions than their own capital permits. Let’s say you are looking at shares of a company named ABC and you strongly believe their price will go up. You have some money, let’s say Rs.25,000, but you wish you could buy more shares to get a bigger profit. This is where margin trading steps in, it is like taking a small loan from your stockbroker to buy more shares than your own cash would allow. You put in a part of the money, and your broker lends you the rest. This way, you get to control a larger number of shares, effectively increasing your purchasing power.   

    Let’s look at a simple example to see how your gains (or losses) can grow. Suppose you have Rs.25,000 and borrow Rs.75,000 to buy shares worth Rs.1,00,000. If the shares go up by 10% (from Rs.1,00,000 to Rs.1,10,000), your profit is Rs.10,000. On your initial Rs.25,000, this is a 40% return.   

    However, if the value of your shares fall by 10% (from Rs.1,00,000 to Rs.90,000), your loss is Rs.10,000. This means you lost 40% of your initial Rs.25,000. This illustrates how margin trading can amplify both profits and losses. When an investor borrows money to increase their buying power, any percentage change in the stock price applies to the total value of the position, not just the investor’s initial capital.   

    Read Also: Difference between Margin Trading and Leverage Trading

    What is Short Selling? 

    Short selling is the practice of selling borrowed securities in anticipation of a price decline, with the aim of buying them back later at a lower price to return to the lender and profit from the difference. Imagine you are watching a company named XYZ and you have a strong feeling that its share price is going to drop because of some reports and news. Most people buy shares hoping they will go up. But what if you could make money when prices go down. This is exactly what short selling allows you to do. 

    Let’s look at a simple example, suppose you think the shares of XYZ, currently trading at Rs.150 will fall. You borrow 100 shares and sell them for Rs.15,000. Later, the price drops to Rs.120. You buy 100 shares for Rs.12,000. You return the shares and your profit is Rs.15,000 – Rs.12,000 = Rs.3,000 (minus broker fees).   

    But if the price goes up to Rs.180, you still have to buy them back at Rs.180 to return them. Your loss would be Rs.15,000 – Rs.18,000 = – Rs.3,000. This illustrates a critical aspect of short selling, the possibility for losses can be unlimited. Unlike buying a stock where losses are capped at the initial investment, there is theoretically no upper limit to how high a stock price can rise.   

    Margin Trading vs. Short Selling

    Now that we understand what margin trading and short selling are individually, let’s look at how they are different. Even though both involve using borrowed funds or shares, their goals and how they work are quite opposite. This will help you clearly see the distinction between buying on margin vs short selling.

    Market Outlook 

    • Margin Trading : You use this strategy when you are hopeful (optimistic) about a stock. You believe its price will go up.   
    • Short Selling : You use this when you are cautious or pessimistic about a stock. You believe its price will go down.   

    How You Make Money

    • Margin Trading : You make money when the price of the shares you bought goes up.   
    • Short Selling : You make money when the price of the shares you sold (which you borrowed) goes down, allowing you to buy them back cheaper.   

    Using Borrowed Funds

    • Margin Trading : You borrow money from your broker to buy more shares.   
    • Short Selling : You borrow shares from your broker to sell them, even though you do not own them.   

    This table will help you quickly understand the main differences between these two strategies.

    Feature Margin Trading Short Selling 
    Market OutlookExpecting price to increaseExpecting prices to fall 
    MechanismMoney is borrowed to increase purchasing powerSecurities are borrowed and sold 
    Profit ConditionsProfit from rising stock priceProfits are earned with declining stock price
    RiskLosses can exceed initial investment, but are limited Unlimited loss potential 
    Market Conditions Works well in bullish marketGreat during bearish market 

    Read Also: Differences Between MTF and Loan Against Shares

    Advantages and Disadvantages

    Every trading strategy in the market comes with its own set of benefits and risks. Both margin trading and short selling are no different. Understanding their upsides and downsides is crucial before you use them.

    Advantages of Margin Trading

    • Increased Buying Power : The biggest advantage is that you can buy more shares than your own money would allow. This means you can participate in larger trades, potentially leading to higher returns.   
    • Potential Profits : If the stock price moves in your favor, your profits can be much higher than if you had only used your own money. The leverage amplifies your gains.   
    • More Flexibility : It gives you quick access to funds. You can take advantage of short-term market opportunities without having to sell your existing investments.   

    Disadvantages of Margin Trading 

    • Magnified Losses : Just as profits are amplified, so are losses. If the stock price falls, you can lose much more than your initial investment.   
    • Interest Payments : The money you borrow from your broker comes with interest charges. These costs can eat into your profits, especially if your gains are small or if you hold the position for a long time.   
    • Risk of Margin Calls & Liquidation : If your investment drops significantly, you might get a ‘margin call’ asking for more money. If you cannot pay, your broker can sell your shares, leading to forced losses.   

    Short Selling Advantages

    • Profits : This is unique as short selling allows you to make money even when the overall market or a specific stock is going down. This is very useful in a ‘bearish’ market.   
    • Hedging : You can use short selling as a protective shield for your existing investments. If you own many shares, short selling a few related ones can help reduce your overall risk if the market drops.   
    • Fair Prices : Short sellers often bet against companies they believe are overvalued. This activity helps bring down inflated stock prices, making the market more fair and efficient.   

    Short Selling Disadvantages

    • Unlimited Losses : This is the biggest and most serious risk. Unlike buying a stock where you can only lose what you invested, a stock’s price can theoretically rise endlessly. This means your losses from short selling could be much, much larger than you expect.   
    • Margin Calls : If the price of the stock you shorted starts to rise sharply, your broker will likely issue a margin call, asking for more funds.   
    • Knowledge & Timing : Short selling is complex, it requires deep research, accurate predictions, and excellent timing. It is generally not for beginners.    

    Read Also: Difference Between Intraday Trading and Delivery Trading

    Conclusion

    You now understand the core difference between margin trading and short selling, and what it means when people talk about buying on margin vs short selling. Both strategies offer unique ways to potentially make money in the stock market, whether you are hopeful about rising prices or cautious about falling ones.

    However, it is very important to remember that both these strategies involve using borrowed money or shares. This means they can amplify your profits, but they can also dramatically increase your losses. They are not for everyone, especially not for those new to the market. Always approach them with a clear mind, thorough research, and a strong understanding of the risks involved. Your financial journey is unique, and what works for one person might not work for another.

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    Frequently Asked Questions (FAQs)

    1. Do every stock broker provide margin trading and short selling facility?

      No, not all stock brokers offer these facilities. To engage in margin trading, you need a broker that provides a ‘Margin Trading Facility’ (MTF). For both margin trading and short selling, you will need to open a special ‘margin account’ with your broker.

    2. How much shall I invest to start margin trading?

      There is not one fixed amount, as it depends on your broker’s rules and the price of the shares you want to buy. Brokers usually ask for an ‘initial margin’, which is a percentage of the total value of the shares (often around 20% to 25% for stocks).   

    3. In India, is short selling limited to intraday trades?

      For regular stock trading (cash segment) by retail investors in India, short selling is generally restricted to ‘intraday’ trading. This means you must close your position (buy back the shares) by the end of the same trading day.   

    4. How can I mitigate risks?

      These strategies carry high risks, so protecting your money is very important. Start small, use stop loss orders, avoid over leveraging, research thoroughly, monitor regularly, maintain sufficient funds.

    5. Are profits from margin trading and short selling taxable?

      Yes, both are taxable. Profits or losses are treated as business income or capital gains depending on how frequently you trade, and you are required to report them while filing taxes.

  • What is Delivery Trading?

    What is Delivery Trading?

    Delivery trading is a form of stock market trading where shares are purchased and held in a demat account beyond the same trading day. Unlike intraday trading, where positions are squared off before market close, delivery trading allows traders to carry forward their holdings beyond a single day, often for several days or weeks, in order to benefit from larger price movements. 

    In this blog, we will explore delivery trading in detail, including how it works, the advantages and disadvantages, the charges involved, and the rules that protect investors.

    Delivery Trading: An Overview

    In the simplest terms, it is the process of buying shares of a company and holding them for more than one day. When you do delivery trading, the shares you buy are stored electronically in a special account called a Demat account.   

    Once the shares are in your Demat account, you become a part owner of that company or the shareholder of the company. You can hold these shares for as long as you want a few days, a few weeks, or several months. In delivery trading, the objective is not to earn quick profits but to benefit from broader price movements identified through patterns or technical indicators over a longer horizon.   

    How Delivery Trading Works?

    The process might sound technical, but it’s quite straightforward. Let’s follow the process of delivery trading in detail.

    1. Order Placement : You log into your stockbroker’s app (like Pocketful). You search for a company you have analyzed, decide how many shares to buy, and most importantly, you select the ‘Invest’ option for the shares. For this, you must have the entire purchase amount available in your trading account.   
    2. Exchange Matchmaking : Your buy order goes to the stock exchange (like NSE or BSE). The exchange’s electronic order book matches your buy order with sell orders at the best price and your trade is executed.   
    3. T+1 Settlement : In India, exchanges follow a T+1 settlement cycle. ‘T’ stands for the trading day. So, T+1 means one working day after the trade has been executed.    
    4. Shares Credited in Your Demat Account : On the T+1 day, the money for the shares is debited from your trading account. In return, the shares are officially transferred and credited to your Demat account. Congratulations, you are now the owner of those shares   

    This T+1 system is a safety feature introduced by SEBI, our market regulator. It means you get your shares faster when you buy, and you get your money faster when you sell, making the whole system safer and more efficient for retail investors like you.   

    Read Also: Difference Between Intraday Trading and Delivery Trading

    Advantages and Disadvantages of Delivery Trading

    Advantages

    1. Real Ownership : This is the biggest benefit, as a shareholder you get certain perks. If the company makes a profit, it might share some of it with you as ‘dividends’. You may also get bonus shares and have the right to vote in important company decisions. You don’t just own the stock, you own a piece of the company .   
    2. Potential Wealth: Delivery trading can be a strong path to wealth creation. As good companies grow, their stock prices often follow. By holding shares for longer periods, you position yourself to capture significant price movements, which can transform a relatively small investment into a much larger return.   
    3. Less Stressful : You don’t need to be monitoring the screen all day watching prices go up and down. Since you are in it for the long run, daily market noise doesn’t affect your stock much. This makes it a calmer, less stressful way to invest, perfect for students or working professionals.   
    4. Lower Costs : In delivery trading, you incur fewer charges since you buy and hold. Whereas, an intraday trader might make 10 trades a day, while you might make only 10 trades a year. This results in much lower overall transaction costs in the long run.   
    5. Tax Benefits : If you sell your shares after holding them for more than one year, the profit you make on it is called a Long-Term Capital Gain (LTCG). In India, LTCG is taxed at a lower rate compared to profits from intraday trading, which is considered business income and taxed at your personal income tax slab rate.   

    Disadvantages

    1. Full Payment Upfront : You have to pay 100% of the money upfront. If you want to buy shares worth ₹50,000, you need to have ₹50,000 in your account. You don’t get the high leverage or loans that intraday traders have access to.   
    2. Stagnant Investment : Since you hold stocks for a long duration, your capital is locked. This means you might miss out on other good investment opportunities that pop up because your money is tied up. This is known as the opportunity cost.   
    3. Market Risks : While you avoid daily ups and downs, you are exposed to long-term risks. A bad decision by the company, an economic crisis, or a change in government policy can cause your stock’s price to fall over time.   
    4. Patience : This is not a get-rich-quick scheme. Returns in delivery trading can take months or even years to show. It requires a lot of patience and discipline to not sell in panic during market corrections.   
    5. Higher Taxes: The Securities Transaction Tax (STT), a tax you pay on every trade, is higher for delivery trades compared to intraday trades. While you trade less often, the tax on each sell transaction is higher.   

    Steps to Start Delivery Trading

    Here’s a simple guide on how to start delivery trading in India : 

    Step 1: Documentation –

    You will need three basic documents, your PAN card, your Aadhaar card (make sure it’s linked to your mobile number), and your bank account details (like a cancelled cheque or a bank statement).   

    Step 2: Choose a Stockbroker –

    A stockbroker is necessary to participate in the stock market. Choose a SEBI-registered broker like Pocketful.

    Step 3: Open a Demat and Trading Account –

    This is a fully online process and takes just a few minutes. You will fill a form, upload your documents, and do a quick video verification. For example, Pocketful helps new users to open Trading and Demat accounts free of cost.   

    Step 4: Add Funds –

    Once your account is active, transfer money from your linked bank account to your trading account. You can easily do this using UPI or net banking.   

    Step 5: Do Your Homework –

    Don’t buy a stock just because your friend told you to; do your own research. Read about the company, its fundamentals, what it does, and how it has performed in the past. Choose companies with strong fundamentals.   

    Step 6: Place Your First Order –

    Log in to your trading app, find the stock you want to buy, specify quantity and tap ‘Buy’. Enter the number of shares you want, and remember to select the ‘Invest’ option. Once you confirm, the order is placed. 

    Delivery Trading Charges 

    A common point of confusion for beginners is the cost of trading. Many brokers advertise zero brokerage on delivery trades. But that doesn’t mean delivery trading is completely free, as you still have to pay GST, exchange transaction charges, etc. Here’s a simple breakdown of delivery trading charges:

    • Brokerage : This is the fee your broker charges. For delivery, many popular brokers charge ₹0.   
    • STT (Securities Transaction Tax) : A tax paid to the government on both buying and selling. For delivery, it’s 0.1% of the transaction value.   
    • Exchange Transaction Charges : A small fee charged by the stock exchanges (NSE/BSE) for using their platform.   
    • GST : 18% tax on your brokerage, transaction and other associated charges.   
    • DP Charges : A flat fee charged only when you sell shares from your Demat account.      

    Delivery Trading Rules

    The Indian stock market is well-regulated by SEBI to protect small investors. Here are a few important rules of delivery trading that act as your safety net:

    • T+1 Settlement : Ensures you get your shares or money quickly and reduces risks in the system.   
    • Mandatory Demat Account : All your shares are held safely in an electronic format, eliminating the risk of theft or damage associated with old physical share certificates.   
    • Direct Payout : This is a new rule where shares can be credited directly to your Demat account from the exchange, reducing the broker’s role. This was done to prevent misuse of client shares by brokers, making your investments even safer.   

    Read Also: Different Types of Trading in the Stock Market

    Conclusion

    Delivery trading is a powerful, time-tested approach for building wealth patiently. It is generally more suitable for beginners because it encourages research, discipline, and a long-term mindset. It is less about timing the market and more about time in the market.

    Ultimately, the best trading approach for you depends on your financial goals and your risk appetite. It is advised to consult a financial advisor before trading in the financial markets.

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    Frequently Asked Questions (FAQs)

    1. What is the minimum amount from which I can start delivery trading? 

      There is no fixed minimum amount to start, you just need to pay the full price of the shares you buy. So, your minimum investment is simply the price of one share of the company you want to invest in.   

    2. Can I sell the shares on the same day, even in delivery trading? 

      Yes, you can. However, if you buy and sell a stock on the same day, your broker’s system will automatically treat it as an “Intraday Trade,” and the charges for intraday trading will apply. It only becomes a delivery trade if you hold it for more than a day.   

    3. If my broker says delivery trading is “free,” why are charges still deducted? 

      The free part almost always refers to the brokerage fee only. You still have to pay mandatory government taxes and exchange fees like STT, Stamp Duty, GST, and DP charges. No trade is ever completely free.   

    4. How long can I hold my delivery shares? 

      You can hold them for as long as you wish. There is absolutely no time limit.

    5. What happens after I place a delivery order? 

      When you buy shares, the money is taken from your account, and the shares are credited to your Demat account on the next working day as per T+1 settlement. When you sell, the shares are taken from your Demat account, and the money is credited to your trading account on the next working day.

  • Benefits of Online Trading 

    Benefits of Online Trading 

    Imagine going to a vegetable market about twenty years ago. You would go to your usual vendor, ask for the price of tomatoes, and buy them. You weren’t sure if the next vendor was selling them cheaper, and the whole process took time and effort. You relied completely on that one vendor for the price and quality.   

    For a long time, buying shares of a company was a bit like that. You had to call a person called a broker. You would tell them which share to buy, they would place the order, and the whole process was slow. You had less control and couldn’t see everything happening live.   

    Now, think about how you shop today. You open an app on your phone, see products from hundreds of sellers, compare prices in real-time, and buy with a single click. Online trading is that same powerful change, but for the stock market. It’s like having a giant financial supermarket on your phone.   

    What is Online Trading?

    In simple words, online trading is the process of buying and selling shares of companies via the internet. You can do this through a website or a mobile app, right from the comfort of your home. It has made a complex process simple, turning it into just a few clicks.   

    To get started, you need two accounts that work together like a team. Brokers like Pocketful help you in opening both the accounts at the same time.

    1. The Demat Account

    Think of a Demat account as a secure digital locker. In the old days, when you bought shares, you got physical paper certificates. A Demat account stores your shares electronically, making them safe and easy to manage. You don’t have to worry about losing or damaging any paper.   

    2. The Trading Account

    If the Demat account is the locker, the Trading account is your wallet. This is the account you add money to, from your bank account. When you want to buy or sell shares, you use the money in this trading account to make the transaction.They are opened together because you need the wallet (Trading account) to shop and the locker (Demat account) to store what you’ve bought.   

    Benefits of Online Trading

    The shift to online trading has brought some amazing changes for the common investor in India. Let’s look at the main benefits of online trading.

    1. Full Control and Super Fast Speed

    One of the biggest advantages of online trading is that things are in your complete control. You don’t have to call a broker and wait for them to place your order. You can see the price of a share moving live on your screen and decide which share to buy or sell instantly.   

    If you hear some important news about a company, you can react in seconds, not hours. This quickness is very important in the stock market, where prices can change instantly. You can trade from anywhere from your home, your office, or even while traveling, all you require is an internet connection.   

    2. Lower Costs

    In the past, brokers used to charge a fee based on the value of your trade. If you bought shares worth ₹1,00,000, you might have to pay a significant amount as a fee. Today, online trading is much cheaper.   

    Most modern online brokers, often called “discount brokers,” charge a very small, flat fee on your trades. Most discount brokers charge a flat ₹20 per intraday or F&O trade, while equity delivery trades may incur no brokerage. Lower costs mean more of your potential profits stay with you.    

    3. Multiple Investment Options

    An online trading platform is like a huge shopping mall. You don’t just find one type of product; you find many. This is great because it allows you to spread your investment across different asset classes, which is a smart way to manage risk.   

    In one single app, you can find:

    • Stocks : Buying shares of big companies like Tata Motors or Reliance.
    • Mutual Funds : A basket of many stocks managed by an expert. This is often a good starting point for beginners.  
    • Gold Bonds : A way to invest in gold digitally without buying physical gold.   
    • Exchange Traded Funds : A mix of a stock and a mutual fund that tracks a market index like the Nifty 50.
    • International Stocks : Some platforms even let you buy shares of global companies like Apple or Google.

    4. Information at Your Fingertips

    One of the major advantages of online trading is the access to information. In the past, small investors had to rely on rumors or tips. Today, online platforms give you professional grade tools for free. You get :   

    • Live Charts : To see how a stock’s price has moved over time.
    • Company News : All the latest updates about the companies you are tracking.
    • Research Reports : Analysis from experts to help you understand a company’s health.

    This access to information is incredibly empowering. However, it also brings a new challenge. Having information is not the same as having knowledge. You might see hundreds of news articles and videos, which can be confusing. The real skill is to learn to use these tools to do your own basic research, rather than blindly following “hot tips” from social media or TV channels.   

    5. Transparency

    Remember our vegetable market example? Imagine a market where some vendors have been charging extra. You wouldn’t like that, right? The old stock market was a bit like that. But online trading has brought amazing transparency among the buyers and sellers. You can see the live prices of shares as they change every second. You can even see how many people are trying to buy and sell at different prices. This clear view helps you make a more informed decision.

    Read Also: Different Types of Charges in Online Trading

    Step-by-Step Guide For Online Trading

    Starting your online trading journey might seem difficult, but it’s actually a simple, digital process that can be completed quickly. 

    Step 1: Choose Your Broker

    Your first step is to choose a stockbroker. A broker gives you the platform (the app or website) to trade. It is very important to choose a broker that is registered with SEBI (Securities and Exchange Board of India). This ensures your money is safe.   

    For beginners, a Discount Broker is often a good choice, Pocketful is one of them as it offers low-cost, easy-to-use platforms for you to trade on your own.   

    Step 2: Documentation

    Next, you need to open your Demat and Trading account. Don’t worry, this is now a completely paperless process called e-KYC (Know Your Customer). You will need:  

    • Your PAN Card
    • Your Aadhaar Card (linked to your mobile number for OTP)
    • Proof of your bank account (like a cancelled cheque)

    The process is simple: you fill a form online, upload scanned documents, and then do a quick self-verification.   

    Step 3: Add Money and Place Your First Order

    Once your account is active, you can log in to the trading app. You can add money to your trading account from your linked bank account using familiar methods like UPI or Net Banking.   

    Now, you are ready for your first trade. You can search for a company’s stock, see its price, and if you decide to buy, you just need to enter the quantity and click ‘Buy’. 

    Things to consider before starting your Online Trading Journey

    Online trading gives you immense power and convenience. But this power needs to be handled with care. Many beginners make simple mistakes that can be easily avoided.

    Trading on an app is so easy and fast, it can sometimes feel like a game. This is where emotions can take over and lead to bad decisions. Be careful of these common emotional traps :   

    • Fear Of Missing Out : This happens when you see a stock’s price rising very fast and you jump in to buy it, fearing you’ll miss out. Often, you end up buying at the highest point, just before the price starts to fall.   
    • Panic Selling : This is the opposite. When the market goes down a little, you get scared and sell your good stocks in a hurry, and they start to recover later.   
    • Revenge Trading: After you make a loss, you might feel angry and try to win your money back quickly by making another risky trade. This usually leads to even bigger losses.   
    • Be Careful with Leverage : You might see a feature called “leverage” or “margin” on your trading app. This is like a loan from your broker that lets you trade with more money than you have. For example, with 5x leverage, your ₹10,000 can be used to buy shares worth ₹50,000. This sounds attractive, but it is extremely risky for beginners. 
    • Avoid “Hot Tips” : With so much information online, you will see many “experts” on social media and TV giving “hot tips” for stocks that will supposedly double your money. It is very tempting to follow them, but it is also very risky. Most of these tips are just speculation. Instead of chasing tips, spend a little time learning how to use the research tools that your broker provides for free. Making your own informed decisions is the real path to long-term success.   
    • Online Security : Your trading account has your hard-earned money. It is important to keep it safe.
    • Use a strong, unique password.
    • Always enable Two-Factor Authentication (2FA) for an extra layer of security.
    • Only use official trading apps from SEBI-registered brokers.
    • Be very careful of any website or person promising “guaranteed returns.” There is no such thing as guaranteed returns in the stock market.   

    Read Also: Different Types of Trading in the Stock Market

    Conclusion

    There is no doubt that online trading has been a game-changer for the small traders in India. The benefits of online trading are clear: it is cheaper, faster, and gives you more control and choice than ever before. It has opened the doors of the stock market to everyone.   

    However, the market can be unpredictable, and there are risks involved. Success in the stock market is not a get rich quick race, it is a long-term journey of learning, patience, and making disciplined, thoughtful decisions.    

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    Frequently Asked Questions (FAQs)

    1. Is online trading really safe for a beginner?

      Yes, it is, as long as you are careful. Always choose a well-known, SEBI-registered broker. Treat your login details like you treat your bank password and never share them. 

    2. How much money should I start with? 

      You don’t need a large sum. You can start with as little as a few hundred or a thousand rupees. The goal is to get started and learn, not to invest your life savings on day one.

    3. Can I do online trading from my phone?

      Absolutely! Most brokers have fantastic, easy-to-use mobile apps. You can do everything from buying your first share to checking your portfolio right from your smartphone.

    4. Can a beginner understand and do online trading?

      You don’t need to be a math genius or an economist. The beauty of online trading today is that there are tons of resources like videos, articles, and tutorials that explain things in very simple language. A curious mind is all you need.

    5. Is investing and trading the same thing?

      They are totally different. Investing involves committing capital to assets for the long term with the expectation of earning returns through appreciation, dividends, or interest over several years. Trading, by contrast, focuses on the short term and relies on buying and selling securities frequently to capture gains from price movements and market volatility.

  • What is Forward Marketing?

    What is Forward Marketing?

    Asset prices fluctuate constantly, which often makes investments uncertain and risky. To reduce this risk, investors use the forward market, where the price and terms of a future purchase or sale are agreed upon in advance. This helps protect against price volatility and provides more stability in planning investments.

    In this blog, we explain what a forward market is, how it works, its key features, and its advantages and disadvantages.

    Forward Market : An Overview

    The forward market allows parties to lock in prices today for transactions in the future, mitigating the risk of price volatility in currencies, commodities, or securities. This market is usually over-the-counter (OTC), that is, it does not trade on any exchange but works as a direct deal between two parties (buyers and sellers).

    Understand Forward Market Meaning

    Suppose a company has to make a payment in a foreign currency after 3 months. There is a risk of fluctuations in the price of the currency. In such a situation, the company can lock that rate today through a forward contract. This method is adopted in the forward market so that risk from future price fluctuations can be avoided.

    Commonly Traded Assets

    Contracts are made for a variety of assets in the forward market:

    • Currencies like USD/INR
    • Commodities like gold, oil, wheat
    • Interest Rates to fix future borrowing cost

    How Forward Contracts Work?

    In the forward market, the deal is for the future, but its terms are decided today itself. Let us understand this with a simple example:

    Example : A wheat exporter has to send 1,000 tonnes of wheat abroad after 6 months. But he fears that the price of wheat may fall by then. In such a situation, he decided to enter into a forward contract with a foreign buyer today that he will sell 1,000 tonnes of wheat after 6 months at the rate of ₹2,200 per tonne. In this way, whether the price in the market decreases or increases, he will get the fixed rate.

    Step-by-Step Process:

    • Finalizing the Agreement : Both parties (buyer and seller) make an agreement today regarding the price, quantity and delivery date.
    • There is no immediate payment : In this contract, there is no transaction of actual money or goods. In some cases margin or premium can be taken.
    • Settlement takes place on maturity : When the due date arrives, the asset (such as wheat, currency etc.) is delivered and payment is made as per the contract.

    Such contracts in the forward market help investors and traders to avoid price swings and do financial planning in advance.

    Types of Forward Contracts

    There are four major types of contracts in the forward market, which are based on the structure of the deal and settlement terms. Each type has its own features, which are chosen according to different trading needs:

    1. Closed Outright Forward

    In this, the buyer and seller fix the exchange rate today for a fixed date. This rate is determined by adding the spot price and the premium/discount on it. Settlement takes place only on maturity.

    2. Flexible Forward

    There is some freedom in this contract. The parties can make payment and delivery even before the fixed date. This is beneficial for those whose cash flow needs keep changing.

    3. Long-Dated Forward

    When the maturity of a contract is 1 year or more, it is called long-dated forward. These contracts are often used by large companies or financial institutions to hedge long-term risks.

    4. Non-Deliverable Forward (NDF)

    There is no delivery of actual currency in this. Only the difference between the forward rate and the spot rate of that day is settled in cash. This type is for currencies of countries where there are capital controls, like INR or CNY.

    Key Features of the Forward Market

    • Over-the-Counter (OTC) market : The forward market does not run on the exchange, but it is an OTC (over-the-counter) market, where deals are made directly between two parties. This means that every contract can be fully customized.
    • The contract is completely customizable : In forward contracts, parties can decide things like amount, delivery date, and asset type according to their needs. There is no fixed format in it, which makes it flexible.
    • There is counterparty risk : Since these contracts are OTC, there is a risk of default by one party. No clearing house guarantees.
    • Settlement happens at the time of delivery : In forward contracts there is no daily price adjustment, settlement happens only on the maturity date i.e. when the contract expires.

    Read Also: Low latency trading platforms in India

    Forward Market vs Futures Market

    FeatureForward MarketFutures Market
    Trading StyleOver-the-counter (directly between two parties)Traded on an exchange (like NSE, BSE)
    Nature of contractFully CustomisedStandardized Contracts
    RegulationUnregulatedRegulated (by bodies like SEBI)
    Settlement processPayment and Delivery on MaturityDaily mark-to-market settlement
    Counterparty RiskHigher risk (probability of default)Low risk (through clearinghouse)
    LiquidityLow LiquidityMore liquidity, easy exit possible
    UserCompanies and exporters in generalRetail and Professional Traders

    Importance and Benefits of Forward Markets

    Forward markets are an important risk management tool in the financial world. They are especially beneficial for businesses that are involved in international trade, commodities or currencies.

    • Risk management tool : Forward contracts protect companies from fluctuations in price, foreign exchange and interest rates. This reduces uncertainty and maintains financial stability.
    • Clarity in budget and cost : When a company fixes future prices with a forward contract, it is easier to plan better about input costs and revenue.
    • Customized contracts : Forward contracts are flexible and can be tailored to meet specific requirements such as amount, duration, and delivery terms. This flexibility is not available in futures markets.
    • Choice of large institutions : Corporates, banks, exporters and even governments use forward markets extensively, especially to manage currency exposure.
    • Helpful in long-term planning : These markets promote long-term financial planning rather than short-term speculation. 

    Read Also: Difference Between Forward and Future Contracts Explained

    Risks and Limitations of Forward Markets

    • Counterparty Risk : The biggest risk in forward contracts is that of the counterparty. Because it is an over-the-counter (OTC) deal, no central authority guarantees it. If the other party (such as buyer or seller) refuses to make payment or delivery on time, there can be huge financial losses.
    • Lack of liquidity : The facility of liquidity i.e. cash is limited in the forward market. Most deals are customized and it is difficult to easily transfer them to a third party. For this reason, it is difficult to exit prematurely.
    • Valuation Challenge : Since forward contracts are not standard, it is difficult to determine their current market value. This creates problems in accounting, reporting and risk management, especially when there is volatility in the market.
    • Lack of regulation : The monitoring of government or regulatory bodies on the forward market is limited. This increases the possibility of fraud, misrepresentation and unethical behavior, which can be risky for investors.
    • Misuse of speculation : Some institutions or traders use forward contracts for speculation rather than hedging. This increases both risk and market volatility, especially when the predictions prove to be wrong.
    • Effect of market volatility : If the forward contract is for a long period and during that period there is a huge change in the prices of currency or commodity, then unexpected losses may occur. This risk is difficult to estimate.

    Read Also: Types of Futures and Futures Traders

    Conclusion

    The forward market plays an important role in managing uncertainty by enabling buyers and sellers to fix future prices in advance. At the core of this market are forward contracts, which can be complex but are highly effective in reducing risk when understood and applied correctly. Forward contracts provide flexibility because they can be customized according to specific needs, while futures contracts, which are traded on exchanges, offer greater transparency and security. Before entering into such agreements, it is necessary to carefully assess investment objectives, time horizon and risk appetite. With the right approach, forward contracts can serve both as a hedge against volatility and as a tool for generating profit.

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    Frequently Asked Questions (FAQs)

    1. What is a Forward Market?

      A forward market is a market where a price is fixed today for delivery in the future.

    2. What kind of contracts are traded in the Forward Market?

      Forward contracts are traded in the forward market, which are settled between the buyer and the seller at maturity of the contract.

    3. Is Forward Market regulated like a stock exchange?

      No, the forward market is mostly unregulated and operates OTC (Over the Counter).

    4. Who uses the Forward Market the most?

      Exporters, importers and large companies mostly use the forward market.

    5. What is the main benefit of Forward Market?

      It helps to hedge against price risk, especially in currency or commodity markets.

    6. Is there any risk in trading forward contracts?

      Yes, there is counterparty risk as these contracts are private.

  • Best Brokers for Low Latency Trading in India 2025

    Best Brokers for Low Latency Trading in India 2025

    In today’s stock market, every millisecond matters, and this is what decides whether your trading positions are profitable or loss-making. In such a situation, it is important to choose the broker with the lowest latency in India, which will deliver your order to the exchange at the fastest speed. 

    In this blog, we will know which brokers are considered the fastest in India, what factors determine latency and which is the right choice for different trading styles.

    What is Latency in Stock Market Trading?

    Latency is the time delay between when a trader places an order and when it reaches the exchange for execution. If this time is very less, then your order will be fulfilled immediately and at the desired price. The higher the latency, the greater the chance of slippage (price difference).

    Order Journey

    Every trade order follows a sequence of steps before it gets executed:

    • Trader’s system or Mobile App, on which a person places an order.
    • Broker’s OMS and RMS systems, where security, margin and risk checks are done
    • Stock exchange receives the validated order and order gets executed
    • Exchange sends the confirmation which is sent to the trader via broker.

    Each step takes a few milliseconds. These may sound very small, but in a fast market these moments can decide profits and losses.

    Low Latency vs High Latency Brokers

    Low Latency Brokers: Brokers whose servers and network infrastructures are placed near the exchange. These brokers use the latest technology, which allows the order to be executed almost instantly.

    High Latency Brokers: Their systems are slow to respond, due to which orders get executed after a delay during which the prices may change.

    Effect of Latency

    The effect of latency is clearly visible in a fast-changing market. Suppose you have decided to buy shares at ₹ 100. If your order reaches the exchange 1–2 seconds late, the price can go up to ₹ 100.20 or even above, resulting in a higher buying price. The effect of latency is far more significant in options trading which are volatile financial instruments.

    Top 5 Best Lowest Latency Brokers in India

    S.NoBrokerBroker Response Time (ms)
    1Pocketful Lower than 50 ms 
    2Zerodha 65 ms to 75 ms 
    3Upstox 55 ms to 65 ms 
    4Fyers 60 ms to 70 ms 
    5Angel One 75 ms to 85 ms

    Note: All these are approximate numbers and may vary across devices, internet speeds, and market conditions.

    Read Also: Best Trading Apps in India

    Overview of Lowest Latency Brokers in India 

    An overview of the lowest latency brokers in India is given below:

    1. Pocketful

    Pocketful provides institutional-grade trading speed of under 50 ms, making it one of the fastest brokers for both retail and algo traders. APIs like Order API, Market Data API, Portfolio API, and Funds API give you easy and fast access to real-time order placement, market data, portfolio information, and fund status. The best part is that Pocketful offers Trading APIs for free. OAuth2-based login process, Python SDKs, and other supporting API documentations make the development of algorithmic trading processes simple and scalable.

    2. Zerodha

    Zerodha’s Kite Connect APIs are widely used by algo traders, but the benefit of low latency execution also helps retail traders who prefer manual trading. It allows you to easily place orders, access live market data and historical charts, as well as portfolio and position management. Supporting both REST and WebSocket, Zerodha ensures stable and fast connectivity for traders of all levels.

    3. Upstox

    Upstox offers trading APIs built for speed and reliability, making it appealing to both retail and algorithmic traders who value low latency. It supports REST and WebSocket connections, enabling access to order placement, live market data, market depth, option chains, and portfolio management. The latest version of the API continues to add features that enhance flexibility and overall trading experience.

    4. FYERS

    FYERS offers a reliable and scalable platform suitable for both retail and algorithmic traders. It provides a scalable, REST and WebSocket based platform where you can find APIS related to order placement, market data, funds, etc. Retail traders benefit from quick order fulfillment, while algo traders can handle up to 1 lakh requests/day, making it ideal for advanced strategies.

    5. Angel One

    Angel One provides a reliable trading platform with low latency, making it suitable for both retail and algorithmic traders. Its SmartAPI includes Market Feeds, Historical Data, Publisher API, and Trading API, all integrated into one system. Supporting both REST and WebSocket, it enables tick-by-tick data, faster order placement, and efficient backtesting. SmartAPI is also available in multiple SDKs such as Python, NodeJS, and Java, supported by an active developer community.

    Read Also: Top 10 Demat Account in India

    Why Latency Matters for Traders?

    Latency is important for traders due to the following reasons:

    • Importance of every tick for scalpers : Scalping traders make profits from very small price movements. Here it is very important to have the broker with lowest latency because even a delay of one second can turn their profits into losses.
    • Fast speed for options traders : The options market is very volatile especially at the time of expiry and news events. If your broker is slow,you may not be able to get entry or exit at the right price. This is why choosing the fastest stock broker is important for options traders.
    • Success in Algo trading : The success of Algo trading strategies is completely dependent on speed. If the latency is high, the entire model can give wrong signals and the profits may turn into losses.
    • Reduces Slippage Costs: Latency has a direct effect on the price at which your order gets executed. For retail traders and investors, even small delays can mean paying more when buying or receiving less when selling. For example, if your order is filled in 40 milliseconds you might get the stock at ₹100.00, but a delay of 100 milliseconds might get the same order filled at ₹100.20 or more if the stock is in an uptrend. 

    Key Factors Affecting Broker Latency

    Some of the key factors that affect the latency of a brokers are given below:

    1. Speed ​​of OMS and RMS systems

    Each brokerage has its own Order Management System (OMS) and Risk Management System (RMS). The order undergoes risk checks and verification before it reaches the exchange. If these systems are fast and efficient, latency is low. On the other hand, brokers operating on outdated technology may experience slower order processing, causing delays in execution.

    2. Server location

    Where the broker’s servers are located has a direct impact on latency. For brokers whose servers are located in a co-location facility of NSE or BSE, the order travels a very short distance. The result: order processing time is reduced significantly.

    3. Trading API and platform design

    The design of trading APIs also makes a difference.

    • WebSocket APIs provide live data streams and require fast updates.
    • REST APIs can be a little slower as every request is a new call.

    A good broker balances both and provides data with minimal latency.

    4. Network infrastructure and load handling

    Order volume increases suddenly at market opening (9:15 am) and on expiry days. At such times, how strong the broker’s network and trading infrastructure is matters a lot. If the infrastructure is scalable, it will handle the load and will remain stable. However, brokers with outdated systems may experience sudden spikes in latency during periods of high market volatility.

    Read Also: Top 10 Highest Leverage Brokers in India

    Conclusion 

    In a fast-changing market, every second is precious. In such a situation, the right broker is the one that fulfills your order without delay and with reliability. If you do scalping, options or algo trading, then it is important for you to choose the broker with lowest latency. A stable, high-speed platform not only helps secure better prices but also ensures your trading strategies work as intended.

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    Frequently Asked Questions (FAQs)

    1. What is latency in stock trading?

      Latency is the time delay between when a trader places an order and when it reaches the exchange for execution.

    2. Which broker has the lowest latency in India?

      Pocketful is recognized as one of the brokers in India with the lowest latency, making it highly reliable for fast trade execution.

    3. Does every trader need a low latency broker?

      Yes. While low latency is critical for scalpers, options traders, and algorithmic strategies, even long-term retail investors benefit from faster execution. A low latency broker helps secure better prices, reduces the risk of slippage, and ensures reliability during volatile market conditions

    4. What factors affect broker latency?

      Broker’s server location, technology, OMS/RMS efficiency, internet speed, and market volatility directly impact latency and execution speed.

    5. Do all brokers disclose their latency?

      No, most brokers don’t publish exact latency figures. Traders usually rely on independent tests or personal trading experience.

  • What is Trading on Equity?

    What is Trading on Equity?

    What if you want to buy a house and it costs Rs.50 Lakh, but you only have Rs.10 Lakhs in savings and you really want to buy it. What would you do, you walk into a bank, use your Rs.10 lakh as a down payment; this is your ‘equity’, and you take a loan for the remaining Rs.40 lakh. 

    Now, after a year and half, the value of your house rises up by 10% to Rs.55 lakh, giving you Rs.5 lakh profit. But look, you only invested Rs.10 lakh of your own money. So, on your personal investment, you’ve made a good 50% return (Rs.5 lakh profit/Rs.10 lakh investment). This magnifying effect is the superpower of using borrowed money also known as leverage in the stock market.

    The big companies that you invest in also use the exact same, when a company uses borrowed money to boost profits for its owners (the shareholders, like you), it’s called trading on equity.

    What is Trading on Equity?

    Trading on Equity is a financial strategy where a company uses borrowed funds, like loans from banks or money raised by issuing debentures to investors, to buy assets or fund new projects.   

    The goal here is simple to earn a higher rate of return from these new investments than the interest rate it has to pay on the borrowed money. Any extra profit made goes directly to the shareholders, increasing their earnings. This method is also famously known as ‘financial leverage’.   

    It doesn’t mean the company is trading its own shares. Instead, it means the company is using its existing equity, the money invested by the owners acting as a strong base or foundation to get these loans. Lenders are more willing to give money to a company that has a solid financial hold, which comes from its equity.   

    How does Trading on Equity work?

    Harjyot Textiles is doing well and wants to open a new factory to expand its business. It needs Rs.20 lakh for this. The company’s owners (shareholders) have already put in Rs.10 lakh, which is its current equity capital (10,000 shares worth Rs.100 each).

    The company expects the new factory to earn a profit of Rs. 4 lakh every year before paying interest and taxes (this is called EBIT). The tax rate is 30% now, the management has two main options to raise the extra Rs.10 lakh.

    Option 1 : Use Only Equity, the company can ask its existing owners or new investors for fulfillment of  Rs.10 lakh by issuing 10,000 new shares.

    Option 2 : Use Debt (Trading on Equity), the company can borrow the entire Rs.10 lakh from a bank at a 10% interest rate.

    Let’s see how your earnings as a shareholder change in both scenarios. We will look at a key metric called Earnings Per Share (EPS), which tells you how much profit the company makes for each share.   

    Particulars All Equity All Debt 
    Earnings Before Interest & Tax (EBIT)₹4,00,000₹4,00,000
    Interest on Loan₹0₹1,00,000 (10% of ₹10 lakh)
    Earnings Before Tax (EBT)₹4,00,000₹3,00,000
    Tax @ 30%₹1,20,000₹90,000
    Earnings for Shareholders₹2,80,000₹2,10,000
    Number of Shares20,000 (10k old + 10k new)10,000 (Only old shares)
    Earnings Per Share (EPS)₹14.00 (2,80,000/20,000)₹21.00 (2,10,000/10,000)

    Even though the total profit for shareholders was lower in Option 2 (because of the interest payment), your earning per share jumped from Rs.14 to Rs.21. This happened because the profit was shared among fewer shares. This is trading on equity working its magic.   

    But remember, this is a double-edged sword. What if the new factory doesn’t do well and only makes an EBIT of Rs.50,000, then

    Particulars All Equity All Debt 
    Earnings Before Interest & Tax (EBIT)₹50,000₹50,000
    Less: Interest on Loan₹0₹1,00,000 (10% of ₹10 lakh)
    Earnings Before Tax (EBT)₹50,000– ₹50,000 (Loss)
    Less: Tax @ 30%₹15,000₹0 (No Tax on losses)
    Earnings for Shareholders₹35,000– ₹50,000 (Loss)
    Number of Shares20,00010,000 
    Earnings Per Share (EPS)₹1.75– ₹5.00

    When things went bad, the debt magnified the losses. Your EPS crashed to a loss of Rs.5, while with the all-equity option, you still made a small profit. This is the risk that comes with this strategy.

    Read Also: Equity Shares: Definition, Advantages, and Disadvantages

    Types of Trading on equity 

    Companies can decide how much risk they want to take. This choice leads to two different styles or types of trading on equity.   

    1. Trading on Thin Equity

    This is the high-risk, high-reward approach. A company is said to be trading on thin equity when its borrowed money (debt) is much higher than its own money (equity).   

    • Imagine a company that has Rs.20 crore of its own equity but has taken loans worth Rs.80 crore. This company is heavily reliant on debt.
    • This is common for companies that need a lot of money to expand, like infrastructure or new-age technology companies. They are betting big on future growth.   

    2. Trading on Thick Equity

    This is the safe, conservative approach. A company is trading on thick equity when it uses more of its own funds and has a relatively small amount of debt.   

    • A company with Rs.80 crore of its own equity and only Rs.20 crore in loans is trading on thick equity.
    • This is often seen in stable, mature companies that value financial strength and have predictable earnings. They are not chasing instant growth but prefer stability.   

    Advantages and Disadvantages of Trading on Equity

    Advantages of Trading on Equity

    1. Higher Returns : As the above mentioned example showed, when a company succeeds, this strategy can significantly boost the Earnings Per Share (EPS). This makes your shares more profitable and can lead to a higher share price.   
    2. Saves Tax : The interest paid by a company on its loans is considered a business expense. This means it can be deducted from the earnings before tax is calculated. This lowers the company’s tax bill, leaving more money for growth.   
    3. Owners Control : When a company raises money by taking a loan, it doesn’t have to issue new shares. This means the existing owners don’t see their ownership percentage get smaller and they keep full control of the company.   
    4. Faster Growth : This strategy gives companies access to large amounts of money to fund big projects, buy other companies, or expand much faster than they could using only their own funds.   
    5. Increase Share Price : A company that uses debt wisely to grow its profits and EPS is often rewarded by the stock market. A higher EPS can lead to a higher share price, increasing the value of your investment.   

    Disadvantages of Trading on Equity

    1. Bigger Losses : Just as profits are high, losses are too. If an investment fails, the company still has to pay back the entire loan with interest, which can wipe out shareholder profits.   
    2. Fixed Interest Payments : A loan’s interest payment is a fixed cost. It must be paid every month or year, whether the company is making profits or not. During a bad year, this can put a huge strain on the company’s finances.   
    3. Risk of Bankruptcy : If a company is unable to make its interest payments for too long, the lenders can take legal action and force the company into bankruptcy. In this case, shareholders are last in line to get paid and can lose their entire investment.   
    4. Unpredictable Earnings : A company with high debt is more vulnerable to economic shocks. A small dip in sales can cause a huge drop in profits and the share price, making the stock much riskier and more volatile.   
    5. Future Loans : A company that is already loaded with debt (trading on thin equity) might find it very difficult to get more loans in the future. Banks may see it as too risky, limiting the company’s ability to raise funds when it needs them.   

    Difference between Trading on Equity and Equity trading 

    This is a very common point of confusion, so let’s make it crystal clear. The two terms sound almost the same, but they are completely different worlds.   

    Trading on Equity is a strategic decision made inside a company’s boardroom, where the company’s management uses borrowed money (like loans) to fund projects, aiming to earn more than the interest on the loan and thereby boost profits for its shareholders.   

    On the other hand, Equity Trading is simply the act of buying and selling shares of companies in the stock market, with the goal of making a profit from the changes in the stock’s price.   

    One is a corporate financing strategy, while the other is a market investment activity.

    Conclusion

    As an investor, it’s important to assess whether a company is using trading on equity and how aggressively it is doing so. This insight is a crucial part of your research, as it reveals the real risks behind your investment. A company with high debt isn’t necessarily a bad choice, just as one with low debt isn’t automatically safe. What truly matters is the company’s ability to remain financially stable and generate sufficient profits to comfortably meet its obligations.

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    Frequently Asked Questions (FAQs)

    1. What is trading on equity?

      Trading on equity is when a company uses borrowed money to invest in its business, hoping to earn more profit from the investment than the interest it pays on the loan.

    2. How does trading on equity affect a company’s stock price?

      It increases the company’s Earnings Per Share (EPS), which often makes the stock more attractive to investors and can drive the price up. If it fails, it can lead to heavy losses, reduce investor confidence, and cause the stock price to fall.   

    3. Why is high debt of a company considered as a bad investment? 

      Not necessarily. A company might have high debt because it is investing heavily in future growth (trading on thin equity). The key is whether its earnings are stable and large enough to easily cover its interest payments. The high debt might lead to higher returns for you.

    4. What is the difference between ‘thin’ and ‘thick’ equity? 

      ‘Thin’ equity means a company has a lot more debt than its own capital, which is a high-risk, high-reward strategy. ‘Thick’ equity means the company has more of its own capital and less debt, which is a safer, more conservative approach.   

    5. Is trading on equity the same as a Leveraged Buyout (LBO)? 

      They are related but not the same. Trading on equity is a general strategy any company can use for growth. A Leveraged Buyout (LBO) is a specific event where a company (often a private equity firm) uses a massive amount of debt to buy another entire company. An LBO is an extreme form of trading on equity.

  • What is Volatility Arbitrage?

    What is Volatility Arbitrage?

    Stock prices do not always move upward or downward consistently. Instead, they often experience volatility, meaning frequent fluctuations. Some traders use this volatility as an opportunity through a strategy known as volatility arbitrage. Unlike traditional trading methods that rely on price direction, this strategy focuses on profiting from the market’s unpredictable behavior.

    In this blog, we will understand what a volatility arbitrage strategy is, how it works and why it is becoming increasingly popular among traders.

    Basic understanding of Volatility

    Volatility is a statistical measure of the degree of variation in the price of a financial instrument over time. In simple terms, it reflects how much and how quickly prices move. When the price of a stock or index fluctuates very rapidly, it is called “high volatility”. Whereas when the movement is less, it is called “low volatility”. But volatility is not just the movement of prices, but it is also an indication of risk and uncertainty.

    Implied Volatility vs Historical Volatility

    • Implied Volatility (IV): This is an estimate of the volatility that is already linked to the price of the option. That is, it gives us an idea about what traders think about how volatile the prices can be in the future.
    • Historical Volatility (HV): This is based on the movement of a stock in the past days, that is, how much fluctuation happened earlier.
    • Realized Volatility (RV): Actual volatility observed after the trade or over the chosen holding period.

    It is very important to understand the difference between them, because the base of volatility arbitrage rests on this difference.

    Role of volatility in option pricing

    Volatility directly affects the price of an option. High volatility = expensive options, and low volatility = cheap options. Therefore, understanding volatility in option trading is as important as understanding price trends.

    Tools to measure volatility

    • VIX Index (India VIX): Estimate volatility coming from Nifty options
    • IV Chart: To track the implied volatility of a stock or index
    • Option Chain Analysis: IV and premium comparison

    Sometimes the stock price remains stable, but volatility increases. For example the week before the results. The stock is not moving much, but investors are feeling uncertainty, which increases IV.

    To understand the volatility arbitrage definition properly, it is first necessary to understand the behavior of this volatility. This is the first step to moving towards strategies like volatility arbitrage.

    Read Also: Commodity Arbitrage – Types & Strategies in India

    What is Volatility Arbitrage?

    Volatility arbitrage is a trading strategy that focuses more on the uncertainty of a stock or index rather than its price movement. In this strategy, traders compare the volatility estimates hidden in the price of options with the fluctuations in the real market. When there is a difference between the two, that is where the trading opportunity arises.

    This strategy is considered special because in this, no bets are placed on whether the price will go up or down. In this, traders focus on how much the market will move, i.e. how much volatility it will have. For this reason, it is also called a market-neutral strategy, which provides protection from directional risk to a great extent.

    In which instruments is this strategy used?

    Volatility arbitrage is used in many different markets, such as:

    • Equity options : based on a single stock (e.g. HDFC, TCS)
    • Index options : based on broader markets (e.g. NIFTY, BANKNIFTY)
    • Commodity options :  like gold or crude oil
    • Currency options : like USD-INR

    Most professional traders in India apply it to index options as they have both high liquidity and volatility.

    How does Volatility Arbitrage work?

    • Identification: First, options are found in which the volatility estimate (IV) is higher or lower than the reality.
    • Creating a position: An option trade setup is created that is delta-neutral, i.e., does not have much impact on the directional move.
    • Hedging: The option trade is hedged by taking a position in the underlying asset.
    • Realization: As time passes, the actual volatility in the market is revealed. If it matches your estimate, you make a profit.
    • Understand with a simple example : Suppose the option price of a stock is indicating that there can be a huge movement in the next month (IV is high), but you think that the movement will be less by looking at the past data and the current environment. In such a situation, you can sell that option. If the stock actually remains stable, then the value of the option falls and you make a profit.

    How Volatility Arbitrage Strategy Works – Step-by-Step Guide

    To understand the volatility arbitrage strategy, it is important to look at it in stages. It is not a simple trading, but every step is a well-thought-out risk and mathematical planning. The complete process of its working is given below in detail:

    Step 1: Identify mispricing in volatility

    Identify mispricing in volatility by checking where Implied Volatility (IV) is much higher or lower than Historical Volatility (HV). Later, during the trade, compare IV against Realized Volatility (RV) to see if your forecast was correct.

    Step 2: Create a Delta-Neutral position

    Once you have found the opportunity, the next step is to create a delta-neutral setup. In this, an option structure is chosen in which the effect of directional movement is minimal. For example:

    • Long straddle
    • Short strangle

    The idea is that the price moves up or down, and profits are based solely on volatility.

    Step 3: Hedge the Underlying

    Maintaining a delta-neutral position requires that you buy/sell the underlying asset in the correct amount. This neutralizes directional risk to a large extent and you are actually betting only on volatility.

    Step 4: Monitor Implied vs Realized Volatility

    It is important to constantly analyze the changes in IV and RV during the trade. If you have taken a long volatility position, you want RV to increase. And if you have a short volatility position, you want RV to remain stable or low.

    Step 5: Exit at the right time

    As soon as the volatility in the market changes as per your expectations, or the mispricing of the option ends, that is when you should close the trade. Delaying can reduce profits or increase the risk of going in the wrong direction.

    Read Also: What is Implied Volatility in Options Trading

    Common Volatility Arbitrage Strategies

    Volatility arbitrage strategy can be adopted in many forms according to different trading conditions. Here we will understand some common strategies popular in India and used by professionals, which help in earning profit from the difference between implied and realized volatility.

    1. Long Volatility Arbitrage

    When the Implied Volatility (IV) of an option is very low and you feel that there will be a sudden big movement in the market (e.g. earnings, budget, RBI policy), then you use Long Vol Arbitrage. In this, ATM or OTM call and put options are bought, such as Long Straddle or Strangle.

    Objective: To earn profit in option premium due to increase in volatility.

    2. Short Volatility Arbitrage

    When IV is very high but the actual volatility in the market is likely to remain stable, then this strategy is adopted. In this, the trader sells options — such as Short Strangle or Iron Condor. This is beneficial when the market remains sideways or less volatile.

    Objective: Earn money from the fall in option premium due to decrease in volatility.

    3. Volatility Spread Arbitrage (Statistical Arbitrage)

    It involves taking trades by looking at the volatility spreads between two related stocks or indices. For example, in NIFTY and BANKNIFTY, if the IV of one has increased sharply and the other has not, then a statistical arbitrage setup can be created by going long one and shorting the other.

    Example: IV spike in BANKNIFTY and stability in NIFTY – benefit of volatility spread here.

    • Option Spreads for Volatility Arbitrage : Some traders use calendar spreads (buy/sell at different expiry) or ratio spreads (multiple contracts) to profit from volatility while reducing directional risk.
    • Calendar Spread: When near-month IV is low and far-month IV is high
    • Ratio Spread: When expected move is limited and IV is likely to fall

    Tools and Indicators Used by Arbitrage Traders

    A strategy like volatility arbitrage is based not just on concepts but on accurate tools and real-time data. Today, there are platforms available that provide traders with all the tools they need to make volatility-based decisions. Below, we discuss the core indicators and features that make this strategy professional and practical.

    • Implied Volatility (IV) Analysis : Implied volatility is the predictions that the market makes about the future price movement of an asset. A good IV Scanner provides strike-wise and expiry-wise breakdowns to detect hidden mispricings within options which is crucial for volatility arbitrage.
    • Option Greeks Panel : Greeks like Delta, Vega, and Gamma help manage volatility arbitrage, especially Vega, which shows the sensitivity of the option to changes in IV. A smart Greeks panel keeps your positions balanced and risk-neutral by showing real-time exposure.
    • Volatility Surface Visualization : The IV Surface is like a 3D map that shows volatility behavior at different expiries and strikes. This makes it easy to spot unusual distortions and arbitrage-worthy gaps which are difficult to detect manually.
    • Strategy Builder with Backtesting : Multi-leg strategies are common in volatility arbitrage. An intuitive strategy builder allows creating complex structures such as calendar spreads, straddles or Vega-neutral setups without coding knowledge. Backtesting on real market data gives confidence before execution.
    • Real-Time Volatility Tracker : The market moves fast and volatility-based signals do not last long. A centralized dashboard that live tracks IV changes, option spreads and unusual activity making arbitrage decisions fast, data-backed and confident.

    Challenges & Risks in Volatility Arbitrage

    Volatility arbitrage is a well-known strategy, but it is extremely difficult to execute correctly. Here are some of the challenges that often impact traders in the live market:

    • Market Liquidity and Wide Spread Impact : Options contracts do not have equal liquidity at every strike. Sometimes you have to trade at such a wide bid-ask spread that losses start as soon as you take a position. This makes short-term arbitrage opportunities practically ineffective.
    • Execution Speed and Platform Reliability : This strategy demands ultra-fast execution without delay. If your terminal is slow or there is lag in order flow, the edge is completely lost. Hence, a system that can provide stable execution in real-time is a must.
    • Error in Volatility Forecast and Vega Risk : This strategy relies on the estimation of implied volatility. If the future movement of volatility is misread or Vega exposure is high, the entire position is at risk. Hence, it is important to constantly monitor the Greeks.
    • Difference between Realized and Implied Volatility : Sometimes the volatility you expect while entering a trade does not come in the market later. Due to this mismatch, the strategy can give losses even though it looks neutral.
    • Breaking News and Sudden Volatility : Events like earnings, RBI announcements or global tension can suddenly increase or decrease volatility. In such a situation, if hedge or risk controls are not set, capital can be eroded quickly.
    • Constant Monitoring and Active Management : This strategy is not something to be set up and left. It requires constant monitoring – Greeks, exposure, volatility shift and PnL tracking. In such a situation, a good terminal like Pocketful’s trading dashboard helps a lot, which provides real-time volatility tracking, live Greeks analysis and scalping tools.

    Volatility arbitrage seems simple on paper, but is equally demanding in the live market. This is not just a strategy, it is a full-time active process in which execution, analytics and speed all contribute equally.

    Conclusion

    Volatility arbitrage is a thoughtful and advanced strategy that monitors the movement within the market, not just the direction of the price. It is effective only for those traders who understand the data deeply and use the right tools. But entering it without preparation or understanding can be harmful. Therefore, it is important to approach this strategy with good study, proper risk management and discipline before adopting it.

    S.NO.Check Out These Interesting Posts You Might Enjoy!
    1Arbitrage Mutual Funds – What are Arbitrage Funds India | Basics, Taxation & Benefits
    2Arbitrage Trading in India – How Does it Work and Strategies
    3Reverse Cash and Carry Arbitrage Explained
    4Commodity Trading Regulations in India: SEBI Guidelines & Impact
    5Top Algorithmic Trading Strategies

    Frequently Asked Questions (FAQs)

    1. What is volatility arbitrage in simple terms?

      When a trader tries to make a profit by predicting the volatility of the market, it is called volatility arbitrage.

    2. Is volatility arbitrage risky?

      Yes, if the prediction is wrong or the data is not correct, then this strategy can be harmful.

    3. Do I need advanced tools for this strategy?

      Yes, real-time data and fast execution tools are very important for this strategy.

    4. Can beginners use volatility arbitrage?

      Beginners should first learn basic strategies, then gradually adopt such advanced strategies.

    5. Is volatility arbitrage legal in India?

      Yes, it is legal as per SEBI rules, as long as you follow fair practices.

  • How to Calculate F&O Turnover for Trading?

    How to Calculate F&O Turnover for Trading?

    If you trade in F&O i.e. futures and options, then it is very important for you to understand the F&O turnover calculation. It is not only necessary for income tax filing, but it also determines whether you have to get a tax audit done or not. Often people get confused about how to calculate F&O turnover, or whether premium should be included in option turnover calculation or not. 

    In this blog, we will explain to you in simple language how the turnover is calculated for intraday trading and F&O trading, and how it can be calculated correctly.

    What is F&O Turnover in Trading ?

    F&O turnover means the total absolute value of profit and loss in futures and options trading, that is, the figure obtained by adding the profits and losses in all the trades done in the whole year without any plus or minus. From the point of view of income tax, F&O trading is considered non-speculative business income, so knowing its turnover is important for many tax related matters – such as the need for tax audit, choosing the right ITR form and taking advantage of the presumptive scheme under section 44AD.

    For example, suppose you made two deals in futures trading – the first one resulted in a profit of ₹30,000 and the second one resulted in a loss of ₹20,000. In such a case, the turnover will be considered as ₹50,000 (₹30,000 + ₹20,000). Here only the absolute value is taken, that is, the loss is also added by adding plus.

    If we talk about option trading, then along with the absolute value of profit and loss, the premium of the option sold is also added to the turnover. For example, if you sold an option at a premium of ₹ 50 and incurred a loss of ₹ 1,500, then the total turnover will be considered as ₹ 1,550. However, many brokers already add the premium to the P&L in their reports, so it is important to read the report carefully before adding it again.

    Segment-wise calculation for F&O turnover? 

    Calculating turnover is an important process in F&O or Futures & Options trading, especially when you have to decide whether you need to get a tax audit done or not. The method of calculating turnover is different for each segment Futures, Options, and Intraday. Its complete information is given below:

    How to Calculate Turnover in Futures Trading?

    To calculate turnover in the Futures segment, all the profits and losses of the year have to be added to the absolute value. That is, whether it is profit or loss, both are considered positive and added.

    Formula : Futures Turnover = Absolute Profit of all trades + Absolute Loss

    Example: If there is a profit of ₹ 40,000 in one trade and a loss of ₹ 25,000 in the other, then the turnover will be ₹ 65,000.

    Trade NumberProfit/LossCalculation (Absolute Value)
    Trade 1₹40,000 Profit (+)₹40,000
    Trade 2₹25,000 loss (-)₹25,000
    Total Futures Turnover₹65,000

    How to calculate turnover in options trading?

    While calculating turnover in options, two things are added:

    • Absolute value of all profits and losses
    • Premium received from option sale (writing)

    Formula : Options Turnover = Premium received on sale + Absolute profit/loss from trades 

    Example: If you sold an option at a premium of ₹120,000 and Trade 1 : ₹10,000 profit Trade 2 : ₹5,000 loss, then the total turnover will be ₹135,000.

    Trade DetailsProfit/LossCalculation (Absolute Value)
    Premium received on sale₹1,20,000 ₹1,20,000 (premium received on option sold)
    Trade 1₹10,000 Profit (+)₹10,000
    Trade 2₹5,000 Loss (-)₹5,000
    Total Options Turnover₹135,000

    Calculation of F&O turnover in intraday trading

    If you have bought and sold Futures or Options in a single day (Intraday), then it is considered a speculative trade. In such a situation, while calculating turnover, the profit and loss of all trades have to be added to the absolute value.

    Example: ₹6,000 profit and ₹3,000 loss – turnover will be ₹9,000.

    How to calculate turnover in intraday trading?

    Intraday trading, i.e. when you buy and sell shares on the same day (do not take delivery), the method of calculating turnover is slightly different. Here also, not net profit/loss but absolute value is added.

    Intraday Turnover = Absolute Profit + Absolute Loss of all trades

    Trade DetailsProfit/LossCalculation (Absolute Value)
    Trade 1 ₹5,000 Profit (+)₹5,000
    Trade 2 ₹3,000 Loss (-)₹3,000
    Trade 3 ₹2,000 Profit(+)₹2,000
    Total Turnover₹10,000

    F&O Turnover calculation for Income Tax Filing

    F&O or Futures & Options trading is considered non-speculative business income. This means that if you make a profit or loss in F&O, then it has to be shown as business income in the income tax return for this, ITR-3 form is usually filled.

    When is a Tax Audit necessary?

    Turnover (annual turnover)What is your declared profit?Is audit necessary or not?
    ₹10 crore or lessProfit is 6% or more (in digital transactions)No audit required
    ₹10 crore or lessProfit is 8% or more (in cash transactions)No audit required
    ₹10 crore or lessProfit is less than 6%/8% or there is continuous lossAudit is mandatory (Section 44AB applicable)
    Above ₹10 croreIrrespective of the profitAudit is necessary in all circumstances

    “F&O turnover is below ₹2 crore, and you declare profits of at least 6% or more of turnover under Section 44AD. 

    If Turnover is between ₹2 Crore and ₹10 Crore and more than 95% of transactions are digital, a tax audit is not necessary, regardless of profit or loss (Section 44AB).

    – In these two cases audit is not required”

    Common Mistakes in F&O Turnover Calculation

    While calculating F&O turnover, many traders make some important mistakes, which can later create problems in income tax filing. Due to lack of correct calculation, there is not only the risk of filling the wrong ITR form, but an audit may also be required.

    • Considering contract value as turnover: Many people assume that the entire contract value of futures or options is their turnover. Whereas in reality, only profit or loss (which has actually occurred) is added for turnover calculation.
    • Ignoring option premium: It is necessary to include the premium received on options sold in the option turnover calculation. Just taking the difference of buy/sell price is not enough.
    • Excluding loss transactions from calculation: Traders often focus only on profit and ignore losses. Whereas in F&O turnover calculation, both profit and loss have to be added in the absolute value.
    • Choosing the wrong ITR form: Due to incorrect calculation of turnover, many times traders choose the wrong ITR form, like filling ITR-2 or ITR-4 instead of ITR-3, which may later lead to a notice.

    Real-Life Scenarios: How Traders Handle Turnover Calculation

    Every trader has a different trading strategy, some trade less frequently, some trade high volumes daily. These habits determine the calculation of turnover and the requirement for a tax audit. Below are some real-life cases that will help you understand turnover.

    Case 1: Low Volume F&O Trading

    If a few F&O trades are made on a monthly basis and the total turnover is less than ₹10 lakh and the profit is also below the basic exemption limit, then a tax audit is not required. The return can be filed easily through ITR-3 form.

    Case 2: High Volume Intraday + F&O

    If intraday or option trading is done on a daily basis and the turnover reaches ₹2 crore or more, then tax audit becomes mandatory irrespective of how low the profit is as the turnover threshold has been crossed.

    Case 3: High Premium Income from Selling Options

    If option selling is done on a regular basis, and a premium of lakhs of rupees is generated from it, then that entire premium is counted in the turnover. Due to this, the turnover limit can be exceeded quickly, and in such a case also it becomes necessary to get an audit done, irrespective of the actual profit or loss.

    Conclusion

    A correct understanding of F&O turnover is not only important while filing taxes but is also crucial for transparency and long-term compliance of your trading activities. Whether you are doing intraday trading or dealing in options, ignoring turnover calculations can prove costly. Hopefully this guide has given you clear and updated information so that you can do tax planning with confidence and avoid mistakes while filing income tax returns. Correct calculation is the first step towards correct taxes and a strong financial plan.

    Frequently Asked Questions (FAQs)

    1. What is F&O turnover in income tax?

      F&O turnover includes profit/loss of closed trades and sale value (premium) of options.

    2. Is audit required for F&O turnover?

      Yes, if annual turnover exceeds ₹10 crore or if profit is less than 6%/8% of turnover (depending on digital transaction percentage).

    3. How to calculate F&O turnover for ITR?

      Turnover is calculated by adding premium received of options and profit/loss of closed trades.

    4. Which ITR form for F&O trading?

      ITR-3 is mandatory as F&O income is classified as non-speculative business income.

    5. Is F&O income a business income?

      Yes, it is considered as non-speculative business income.

  • What is an Underlying Asset?

    What is an Underlying Asset?

    You may have come across terms like options, futures, or exchange-traded funds (ETFs) while learning about investing and trading. In many of these discussions, you’ll often hear the phrase “underlying asset.” An underlying asset is the actual financial instrument that a derivative or product is based on. It could be a commodity like gold, a stock such as XYZ, or even a market index like the Nifty 50. 

    In this blog, we’ll explain what underlying assets are, why they matter, and the different types you’re likely to encounter as an investor or trader.

    Underlying Asset : An Overview

    An underlying asset is the financial instrument on which a derivative’s value is based. It might be a currency, an index like the Nifty 50, a stock, or even a commodity like gold. The price of a derivatives contract, such as a stock option or futures contract, is therefore determined by the value of the underlying asset.

    Example: Let us say you bought a call option of a stock named ABC Industries. The value of that option is derived from ABC’s actual stock. Thus, the underlying asset is the ABC’s shares. Your option increases in value if the stock price rises.

    Read Also: What is Derivatives?

    Why are Underlying Assets Important? 

    1. They Add Value to Financial Products

    Suppose the underlying asset is similar to an automobile’s engine. The entire structure is powered by it. An option on XYZ stock or a gold future only has value because it is tied to the stock or gold itself. Without the underlying, the derivative contracts are worthless.

    2. They Help You Understand Risks

    The behaviour of various assets varies. While some, like gold or bonds, move more slowly, others, like stocks, fluctuate a lot. By understanding the underlying asset, you can better gauge volatility, risk exposure, and whether the derivative product associated with it fits your comfort zone or not. 

    3. Used to Value Derivatives Contracts

    If you trade options or futures, this is a crucial one. The reason those derivatives contracts exist is because they are linked to the underlying, which is a real asset. That asset, whether it be a stock, index, wheat, or crude oil, is what gives the derivative contract its value.

    4. They Allow You to Hedge

    Underlying assets also make hedging possible. A farmer worried about wheat prices falling, or an investor concerned about a market downturn, can use futures or options contracts to lock in prices and reduce risk.

    Characteristics of the Underlying Assets

    1. Liquidity

    Essentially, liquidity refers to how simple it is to buy or sell something. Large-cap stocks are generally liquid. Usually, you can buy or sell in a matter of seconds. However, there might not be many buyers or sellers for lesser-known assets, so you might be compelled to wait or accept an unfavourable price.

    2. Volatility

    Volatility measures how much an asset’s price moves over time. High volatility means larger price swings, which create both higher risk and greater potential rewards. Low volatility signals more stable prices and slower, steadier growth. Understanding volatility is especially important when trading derivatives like options or futures, since their value is directly influenced by price fluctuations in the underlying asset.

    3. Transparency

    You want assets that provide transparency, where prices, trading volumes, and related news are easily accessible in real time. Stocks, gold, and major currency pairs are usually clear and easy to track. However, if you are dealing with less common instruments that trade in obscure or illiquid markets, it is best to be cautious.

    Types of Underlying Assets

    Now that we have a clear understanding of underlying assets and their significance, we will examine the various kinds that you will come across in everyday life. You may already be familiar with some of these; in fact, you may have invested in them without even knowing they act as underlying assets to their respective derivative contracts.

    1. Stocks

    Shares, also known as stocks, are undoubtedly the most common underlying asset available. When you buy stock options or trade stock futures, you are making a bet on the price movement of the underlying stocks.

    Example: If you buy a call option on XYZ stock, then XYZ stock is your underlying. Therefore, your option gains value if the stock price rises.

    2. Commodities

    These are tangible goods that are traded on exchanges, such as wheat, oil, or gold via derivative contracts. Futures contracts are frequently used by traders to buy or sell them at a fixed rate at a later date.

    For instance, gold is the underlying asset for gold futures & crude oil contracts fluctuate in line with the oil price movements.

    3. Currency

    In the forex market, the most common underlying assets are currency pairs such as USD/INR or EUR/USD. These are especially important for importers, exporters, and international investors who need to manage currency risk. 

    For example, the value of a USD/INR futures contract is determined by the exchange rate between the US dollar and the Indian rupee.

    4. Market Indices

    Instead of trading individual stocks, you can trade entire indices such as the Sensex or Nifty 50. This approach is useful if you want exposure to overall market trends without having to pick specific stocks. 

    For example, when you buy a Nifty 50 option, the index itself serves as the underlying asset.

    5. Bonds & Interest Rates

    Even government or corporate bonds and interest rates can be underlying assets. These are usually used in more technical products like interest rate swaps or bond futures.

    For instance – A 10-year government bond future gets its value from—you guessed it—the 10-year G-Sec.

    Underlying Asset vs Derivative Contracts

    FeatureUnderlying AssetDerivative
    What it isThe actual asset (stock, gold, etc.)A contract based on the underlying asset
    Value comes fromIts price in the market determined by buyers and sellersThe price of the underlying asset and buyers and sellers of derivative contract
    ExamplesStocks, gold, currencies, bondsFutures, options, swaps, forwards
    OwnershipYou own the real assetYou own a right/obligation, not the asset
    Risk levelDepends on asset typeUsually higher due to leverage and time constraints

    Risks Associated with Underlying Assets

    1. Price fluctuations

    Markets can be unpredictable. Prices of stocks, gold, oil, or even currencies can move up and down significantly for a number of reasons. Your investment returns may suffer if your underlying asset moves in the wrong direction.

    Consider the following scenario: You bought a call option anticipating a rise in XYZ stock, but the price of the stock falls instead. Your option may suddenly lose most or all of its value.

    2. Risk to the Market

    High volatility during recessions, wars, or global financial crises can bring everything down, even if your chosen investment is fundamentally sound. It is important to consider the larger picture rather than just your investment.

    3. Issues with Liquidity

    Some assets are more difficult to buy or sell quickly. It could be difficult to find a buyer quickly when you need to sell something that you own, which could mean accepting a price that is less than what you expected.

    For example, certain niche commodities or small-cap stocks may seem attractive at first, but when it comes time to sell, they can turn out to be highly illiquid and difficult to exit.

    Conclusion 

    Simply put, an underlying asset is the real asset that gives value to financial instruments such as futures, options, exchange-traded funds, and more. Knowing the characteristics of the asset that lies “underneath” your derivative contracts, such as a stock, commodity, or even an index, can help you make better investment and trading decisions.

    It can make a significant difference to know what you are betting on, including its expected movement, liquidity, and news sensitivity. The underlying asset determines the risks and rewards you are taking on, regardless of whether you are trading more actively or making long-term investments.

    Frequently Asked Questions (FAQs)

    1. Is the asset always a stock?

      No, underlying assets can be stocks, bonds, currencies, commodities, or even interest rates.

    2. Are all underlying assets bought and sold on stock exchanges?

      A lot of them are, but not all of them. Some underlying assets, like interest rates, cannot be traded directly.

    3. Is gold a real asset?

      Yes, gold is a great example. There are a lot of derivatives, ETFs, and even mutual funds that are based on it.

    4. Why do I need to consider the underlying asset before trading?

      Because the underlying asset determines the risk, volatility, and potential returns of your trade. Its price movements, liquidity, and behavior directly impact how your trading position will perform and whether it aligns with your expectations.

    5. How do I find the asset that an investment product is based on?

      The product details or fact sheet usually have these details. Always check before investing.

  • Collar Options Strategy – Meaning, Example & Benefits

    Collar Options Strategy – Meaning, Example & Benefits

    It is easy to feel good about your investments when the stock market is doing well. But what if you are worried about a sudden drop in the market but still want to stay invested? This is when the collar options strategy comes in. It is a smart and easy way to keep your profits safe without giving up all the upside.

    We will discuss the collar strategy, how it works, when to use it, and what its pros and cons are in this blog. If you know how to use a collar option strategy, you can lower your risk without missing out on opportunities, whether you are a conservative investor or a seasoned trader.

    Understanding the Collar Options Strategy 

    Applying a collar option strategy to your stock investment is like putting on a seatbelt. It protects your investment positions from big losses while still letting you make some gains, but not unlimited ones. This is how it works:

    If you already own 100 shares of a company, you do two things:

    • Buy an OTM put option; it is like insurance. It makes sure that you can sell your stock for a certain amount of money, even if the market crashes.
    • If you sell an OTM call option, you agree to sell your stock for a price above its current market price and get paid a premium for this.

    These two options positions basically “collar” your investment between a lower and upper limit. They protect you on the downside but limit your upside to some extent.

    Example of Collar Options Strategy

    Let us break down the Collar Strategy using an easy example. Suppose you currently own 100 shares of ABC, and the stock price is ₹1,500 per share. Although you have made decent gains, you are also a little anxious about the volatile market ahead.

    Even though you aren’t interested in selling, you also don’t want to take the chance of seeing your gains vanish in a flash. This is precisely where the collar options strategy is useful.

    Step 1: Buy a Put Option

    You buy a put option with a strike price ₹1,400 (OTM put), giving you the right to sell ABC at that price even if it falls below ₹1,400. It is similar to stating, “I will never sell this for less than ₹1,400.” Assume that each put option has a lot size of 100 shares and costs you ₹3,000.

    Step 2: Sell a Call Option

    You also sell a ₹1,600 strike price call option (OTM strike), so you will have to sell it at that price if ABC rises above ₹1,600. However, you receive ₹3,000 for selling the OTM call option.

    Therefore, the ₹3,000 you made from the call covers the ₹3,000 you spent on the put.

    Because you’ll receive protection from the downside without actually paying out of pocket, it’s frequently referred to as a “zero-cost collar.”

    What Could Happen, Then?

    When your options expire, let’s examine three simple scenarios:

    -ABC drops to 1,300

    Instead of losing more, you sell your shares at ₹1,400 as your put option expires ITM. You have minimised your downside.

    -ABC remains at about ₹1,500.

    Neither option is exercised. Nothing changes; you continue to hold your stock. 

    -Now, ABC surges to 1,650

    However, you will have to sell at ₹1,600 because you sold a ₹1,600 call. You lose on any gains over ₹1,600, but you still earn a fair ₹100 profit per share.

     The result is that using collar option strategy is given below:

    • Selling for ₹1,400 is your worst-case scenario.
    • The best price you can get is ₹1,600.
    • Additionally, you did not allocate any additional funds to protect yourself.

    In other words, you created a haven around your investment, which can be quite satisfying, particularly when the markets are volatile.

    Benefits of Collar Options Strategy

    Some of the benefits of using collar options strategy is given below:

    1. Your Downside Has a Floor

    The put you buy is like a policy that protects you. You know the lowest price you will get, no matter how bad the market gets. That’s real peace of mind.

    2. You do not have to sell your shares

    Are you worried but still believe in the company in the long run? A collar keeps you in the market instead of selling at the first sign of trouble.

    3. Sometimes protection is very cheap  

    The money you make from selling the call can help pay for the put or even pay for it all. So you might be able to protect yourself from losses without spending a lot of money.

    4. Helps you keep the money you’ve already made

    A collar helps you protect your profits if your stock has gone up a lot, but it also leaves some room for your call strike to go up.

    5. You set the range

    Choose the strikes that you feel comfortable with. If you want strong protection and are good with capping gains sooner? Pick strikes that are closer. Want more room for moving up? Go wider.

    Read Also: Options Trading Strategies

    Limitations of Collar Options Strategy

    Some of the limitations of using collar options strategy is given below:

    1. You may lose out on significant profits

    You will likely regret selling that call if your stock unexpectedly rises in value because you will ultimately have to sell it at that fixed price even if it continues to rise. Yes, the collar protects you, but it also limits your earnings.

    2. You Must Own the Stock for It to Work

    This is not an approach that you can use randomly. It is intended to protect what you already own, not a stock you plan to buy in the future, so you must already own the stock.

    3. You will have to Watch It

    Options have expiration dates, so you can’t ignore them entirely. You may need to make some changes or switch to new options if the market becomes volatile or the stock moves a lot.

    4. In an extremely bullish market, it is not the best course of action

    A collar may seem like a disappointment if you believe the stock is going to rise. You will lose out on profits after your call strike because your upside is capped. If you were correct about the rally, that can hurt so badly.

    5. There is a slight learning curve

    Learning how puts and calls operate, how to pick the best strikes, and when to start everything up may take some time if one is unfamiliar with options.

    Read Also: What is Options Trading?

    Conclusion 

    The collar strategy is like putting a helmet on your investment. It might not make your investment journey more fun, but it does make it safer. For investors who want to hold on to a stock they trust while reducing downside risk, it’s a practical choice.

    You can protect yourself from big drops, lock in some gains, and stay invested, all without spending much or even anything at all. Yes, your upside is limited, but for many investors, the peace of mind that comes with the collar options trading is worth it. The collar might be the best way to keep your risk under control, especially after the stock has had a good run recently.

    S.NO.Check Out These Interesting Posts You Might Enjoy!
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    4Types of Traders in the Stock Market: Styles, Strategies & Pros and Cons
    5Risk Management In Trading: Meaning, Uses, and Strategies

    Frequently Asked Questions (FAQs)

    1. Is it possible to lose money with a collar options strategy?

      Yes, but only down to the put strike price, so your losses are limited.

    2. What will happen if the stock goes up a lot?

      If it goes above your call strike, you will probably have to sell the stock at that price, which means you cannot earn any more money.

    3. When is the best time to put on a collar?

      When you have already made money on a stock and want to protect it during times of uncertainty.

    4. Can I use a collar on index options?

      You can do something similar with index futures or ETFs, but collars work best with stocks you own.

    5. Is this a good strategy for people who are just starting out?

      Yes, it is one of the easier option strategies and a great way to learn how options can help you control risk.

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