Simplifying how derivative products operate in the stock market – By Prof. Simply Simple TM Hopefully the lesson on “Futures” and “Options” helped you to get a good idea about these concepts. However in all our explanations we had a simplistic example of a farmer and a bread manufacturer which does not represent the manner in which we deal with derivative products in the stock markets. Now that you have understood the example-based explanations, let me try to explain what happens in a real life situation.
Imagine there were several farmers in market. Perhaps a few thousands with a view that price of the Wheat is going to fall in near future (bearish participants)
And several thousand bread manufacturers with a view that price of the wheat is going to rise in the near future (bullish participants)
And a market place where there is free flow of information. It provides a platform to both bullish & bearish participants to execute their trades without even knowing each other or hunting for the counterparties.
The basic fundamentals remain the same as we saw in the farmer and bread manufacturer stories,
But the market provides a platform for several parties and counter parties to come together to trade over stocks about which information is free flowing
This leads to a single future price for all participants, thereby rendering irrelevant the need to know who the buyer for the seller and vice versa
Despite all of the above, the market system independently has all the necessary information about the market participants.
So in a nutshell…
I hope I have succeeded in making you understand the derivative market dynamics and why there is no need to know the names of counter parties, unlike the earlier examples where we had the case of farmer and bread manufacturer who knew each other.