Participants in Derivative Markets

There are different kinds of traders in the derivatives market –

• Hedgers – are traders looking to offset their risks. Farmers, Wholesalers, Consumers of the underlying.
• Speculators – seek to earn lucrative profits based on intuition or research. They can be classified into position-traders, day-traders, or even scalpers.
• Arbitrageurs – seek to make profits from market inefficiencies in terms of price or regulation. If the price of gold in one exchange is $1000 and in the other exchange it is $1005 at the same time, then the trader will buy it at the exchange in which the price is lower and sell it on the exchange where the price is higher, thereby making a riskless profit of $5. This price exploitation will continue till the price difference in both markets becomes negligible.
• Margin Traders – take leverage (debt) for intra-day trading.
• Scalpers – make multiple trades during the day in order to earn small profits from each trade. They trade in huge volumes. A trader buys 10,000 shares of a company and if the price goes up by 0.05 cents, he will sell the shares and make a profit of $500.

For example, A farmer wants to fix the selling price of his crop before the harvest. He is thus hedging his risk. A doctor feels that crude oil prices will rise. He is speculating based on his research or intuition.

Note – The underlying asset is required only to derive the value of the contract. As traders are allowed to take short positions (agreeing to sell the underlying), the seller may or may not be in the possession of the underlying when entering into the contract. Even the buyer may not have any actual use or intentions of the underlying. Thus, most trades are based on speculation.