Introduction
Some informed investors consider equity and derivatives as two sides of the same coin. However, on a comparative scale, derivatives are more flexible and expansive than equity. This article discusses the top differences between equity and derivatives to help you make informed decisions.
What is Equity?
Equity is a financial instrument that transfers a part of the ownership of a company to the holder of such an instrument. A company wiling to get money from the public list their shares on stock exchange(s) to carry their operations or expand their business. After listing, the shares become available to the public, and they buy or sell the shares to grow their capital. Equity is always beneficial to a company because, unlike bank loans, the company does not have to pay any interest to the public.
What are Derivatives?
Unlike equity, derivatives are financial instruments traded through stock exchanges or Over-The-Counter (OTC). While almost all equity trades occur through an exchange, derivatives trades may be executed within or without the stock exchange framework. Some types of derivatives are futures, options, forwards, and swaps. A derivative contract enables a buyer or seller to buy or sell an underlying asset (stock, index, commodity, currency, etc.) at a future date.
Now that you know the definition and primary purpose of equity and derivatives, let's understand the topdifferences between equity and derivativesin the following sections.
What is the Difference Between Equity and Derivatives?
Put theequity vs derivativesdebate to rest with the following points:
Investment Objective
One of the top differences between equity and derivatives is that while equity stocks are a time-independent investment option, derivatives are not. Unlike equity stocks, derivative instruments come with an expiry date.
Equity stocks can be held for as long as an investor wants. Since equity stocks are a time-independent investment option, you can buy them today and sell them any day you want. You can trade equity stocks in two broad ways - intraday and positional. Intraday means buying and selling on the same day. Conversely, positional means holding on to equity stocks until your investment objectives are fulfilled.
Derivatives are of two types - standardised and OTC. Standardised derivatives like futures and options are the most common derivative types in the Indian capital market. Both futures and options are based on an underlying asset. The underlying asset may be equity stocks, indices, currencies, commodities, or even interest rates. However, you cannot hold derivatives forever. Each derivative contract comes with an expiry date, and the contract must be executed, sold, or bought before that date. If you do not sell, the contract simply expires worthless.
Hence, derivatives are best suited for people with extensive experience in the capital market, while equity stocks are for everyone.
Nature
Equity refers to a capital contribution by the business owners to the business. This may be through Initial Public Offering, Follow-on Public Offering, and the like. In contrast, derivatives derive their value from an underlying asset.
While an equity stock's performance depends on various factors, including demand and supply, financial results, macroeconomic factors, etc., equity derivatives depend on the movement of equity stocks. So, if a stock 'XYZ' is the underlying asset of a derivative instrument, the derivative may go up if the stock price increases.
Trade Equity and Derivatives Like a Professional
While predicting a winner in the equity vs derivatives debate is hard, 5paisa provides easy access to both investment instruments. Informed investors invest a part of their capital on equity stocks and the other part in derivatives. While the former gives them steady capital growth, the latter is good for hedging or short-term capital appreciation.
FAQs
The primary purpose of equity is capital appreciation and ownership, while derivatives are used for hedging, speculation, and leveraging. Equity performance is influenced by company and market trends, while derivatives strategies may adapt based on current market conditions.
What is the difference between equity and derivatives? ›
The main difference between derivative and equity is the driver of the value or price. Equity gets its value based on market conditions such as demand and supply and company/economy related events. A derivative, on the other hand, derives value or price from the underlying asset such as index, stock, currency, etc.
Should I invest in equities or derivatives? ›
Choose Stocks If: You prefer steady ownership, long-term growth potential, and are willing to ride out market fluctuations. Choose Derivatives If: You have experience in financial markets, are comfortable with higher risk, and seek diverse trading strategies or risk management tools.
What is the difference between a stock and a derivative? ›
Stocks and bonds are also a means of raising finance for any company. However, derivatives are assets that derive their value from their underlying asset.
Are derivatives riskier than equity? ›
Because the value of derivatives comes from other assets, professional traders tend to buy and sell them to offset risk. For less experienced investors, however, derivatives can have the opposite effect, making their investment portfolios much riskier.
Is an ETF a derivative or equity? ›
Exchange-traded funds (ETFs) are not derivatives. They are pools of money used to buy, hold, and sell a selection of stocks, bonds, or other assets. Their investments do not generally include derivatives. Some specialized ETFs use derivatives like options or futures contracts for specific purposes, such as hedging.
Why equity is better than options? ›
Stock options don't represent ownership unless your right to buy them has vested. In comparison, equity investment means ownership in a business. You buy equity after your stocks trade at a particular value. You do this with the hope the price will continue to rise, increasing the value of your position.
Why not to invest in derivatives? ›
Derivatives can also help investors leverage their positions, such as by buying equities through stock options rather than shares. The main drawbacks of derivatives include counterparty risk, the inherent risks of leverage, and the fact that complicated webs of derivative contracts can lead to systemic risks.
What is the best derivatives to buy? ›
Five of the more popular derivatives are options, single stock futures, warrants, a contract for difference, and index return swaps. Options let investors hedge risk or speculate by taking on more risk. A stock warrant means the holder has the right to buy the stock at a certain price at an agreed-upon date.
What are the 4 derivatives? ›
In finance, there are four basic types of derivatives: forward contracts, futures, swaps, and options.
Those with a higher risk tolerance and a good understanding of the market dynamics may benefit the most from including these financial contracts in their investment portfolio. Derivative trading requires expertise and familiarity with the underlying assets or markets they are based on.
How risky is derivative trading? ›
Another risk associated with derivatives is credit risk—the risk that the counterparty to the derivative contract will default on their obligations. If a counterparty defaults on a derivative contract, the investor may not receive the full value of the contract, leading to losses.
What is the safest asset to own? ›
Cash and on-demand cash deposits are the epitome of safety in the asset world. There's virtually no risk of loss (unless it is lost or stolen), making it a very reliable asset. However, its safety comes at a cost: it generally yields minimal returns, especially when inflation runs high, reducing its purchasing power.
Which is better equity or derivatives? ›
The primary purpose of equity is capital appreciation and ownership, while derivatives are used for hedging, speculation, and leveraging. Equity performance is influenced by company and market trends, while derivatives strategies may adapt based on current market conditions.
Is an equity a derivative? ›
Equity options are the most common type of equity derivative. They provide the right, but not the obligation, to buy (call) or sell (put) a quantity of stock (1 contract = 100 shares of stock), at a set price (strike price), within a certain period of time (prior to the expiration date).
What is a derivative example? ›
What Are Derivatives? Derivatives are securities whose value is dependent on or derived from an underlying asset. For example, an oil futures contract is a type of derivative whose value is based on the market price of oil.
Why are stocks called derivatives? ›
What Is Derivative? Derivatives are financial contracts that derive their value from an underlying asset such as stocks, commodities, currencies etc., and are set between two or more parties, where the value of the derivative is derived from price or value fluctuations of the underlying assets.
What is the difference between cash equities and derivatives? ›
Investors in cash markets have the right to dividends. Investors in derivative markets have no rights to payouts. Investors hold ownership of the asset (share) that they acquired. Investors do not own the asset that they have acquired.
