MONEY MATTERS: Earning Income From Derivatives Market

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Derivative markets serve important roles in the global financial system. While derivatives can be complex, they represent the modern-day versions of practices that have been around for thousands of years, when individuals would place bets with one another or farmers would agree to sell their crops in advance as a form of insurance.

For individual traders, derivatives trading has opened up a wide array of markets for them, allowing them to speculate when the price of something will rise or fall. However, traders must fully understand derivatives markets before they can trade them, as well as the different types of derivatives and derivative products that are available.

Nigeria’s capital market development crossed a significant Rubicon on April 14, 2022, with the launch of the NGX Exchange Traded Derivatives (ETD) Market with Equity Index Futures.

Whilst it has taken so long, analysts believed it is better late than never, as the launch of the derivative product is aimed at increasing the depth and breadth of the Nigerian market, which many say is too shallow for the size of the economy.

With the launch of the derivative market, the NGX listed two Equity Index Futures Contracts, the NGX 30 Index Futures and NGX Pension Index Futures, the NGX noted it would roll out more derivative products to diversify the offerings in the near future, as it hopes to leverage this new asset class as an opportunity for portfolio managers to diversify their portfolios. Unlike Exchange Traded Funds, the exchange traded derivatives are imaginary portfolios, whose pricing and performance are contingent on the underlying assets.

NGX explained that ETDs are standardised, highly regulated, and transparent financial contracts listed and traded on a securities exchange and guaranteed against default through the clearing house of the derivatives exchange.

NGX further explained that the ETDs market will complement existing asset classes, provide investors and other market players with the necessary tools for tactical asset allocation, as well as improve risk and cost management for effective portfolio management. It will further enhance the participation of domestic and international investors in Nigeria’s financial markets, which will positively deepen the market and support the drive towards leveraging the capital market as a lever for sustainable economic growth.

Explaining, the Divisional head, Capital Markets of Nigerian Exchange (NGX) Mr. Jude Chiemeka, said “One of the ways to attract investors into our market is to create products that will meet the aspiration of these investors.

“Today we have equities, fixed income, Exchange Traded products and others. We do realize that the market as it is, is not hedged for investors going for long- or short-term investment and with investors committing all their capital in the investment. Hence the need to have an instrument that will allow investors hedge and express their views at the same time, which is why we conceptualize the derivatives market to control volatility.”

How Derivatives Can Be Used To Earn Income

It is not difficult to create an income stream through simply trading derivatives. And NGX is increasing their effort in enlightening and educating the investors on the product.

Arbitrage Benefit; Arbitrage is essentially buying low and selling high across different markets. When one trades using derivatives, one can maximize the benefits that come with arbitrage trading. Since the prices of the underlying assets are constantly fluctuating, one can optimize the buy low sell high strategy through derivatives trading; particularly, options trading. Another pointer is that prices across both markets may vary, which one can directly take advantage of and earn a profit from.

Earn money on idle shares; Most people do not want to sell shares they buy for the long term. Instead, they wish to take advantage of price fluctuations in volatile shares during the short term. To do so, you can use derivatives instruments. Trading on the derivatives market allows you to conduct such transactions without actually requiring that you sell your shares. This strategy is also known as opting for a physical settlement.

Protection against price fluctuations; Hedging is a common strategy employed by seasoned traders. It is the art of protecting yourself against a drop in the prices of the shares that you currently own. The derivatives market offers products that allow one to hedge against price drops. On the derivatives market, you can also find products that protect you against a sudden increase in the prices of shares that you plan to buy. In tandem, this is known as hedging.

Transferring your Risk; As of now, the most beneficial use of derivatives is the ability for one to transfer their risk feature. When trading derivatives, a risk-averse investor gets to add to their portfolio derivatives that can enhance their security.

Meanwhile, derivatives trading, if done correctly, can easily be used to earn a living.