A speculative trade in a derivative is not supported by an underlying position in cash, but simply implements a view on the future prices of the underlying, at a lower cost. For speculation, several research houses extend MCX tips that are highly reliable and accurate.

Example: A speculator was told by the trading tips provider that the stock price of a particular company will go up from Rs. 200 to Rs. 250 in the next three months and wants to act on this belief by taking a long position in that stock. If he buys 100 shares of this company in spot market (delivery), he needs Rs.200 x 100 = Rs.20000 to enter into this position. If his prediction comes true and the stock price moves up from Rs.200 to Rs.250, he will make a profit of Rs.50 per share and total profit of Rs.50 x 100 shares = Rs.5,000 over an investment of Rs.20,000 which is a return of 25%.

Alternatively, he can take a long position in that stock through futures market as well. Suppose he buys a three months futures contract of that stock (1 lot of 100 shares), he need not pay the full amount today itself and pays only the margin amount today. If the margin required for this stock is 10%, then he needs Rs.200 x 100 x 10% = Rs.2000 to take this long position in futures contract. If the stock price moves to Rs.250 at the end of three months, he makes a profit of Rs.50 x 100 = Rs.5000 from this contract. Since his initial investment was only Rs.2000, his returns from the futures position will be 5,000/2,000 = 250%.

This difference in returns between the spot position and futures position is due to the leverage provided by the futures contracts. This leverage makes the derivatives a preferred product of speculators. However, the same leverage makes the derivatives products highly risky. If the market had moved against his prediction, the losses that investor would have incurred would have been many times the loss on the spot market position.


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