Is Demat Account Mandatory for Derivatives Trading?

Introduction: 

Derivatives are contracts that derive their value from an underlying assets. These assets can be stocks, bonds, commodities, currencies, exchange rates, rates of interest, or market indices.

Additional Read: Introduction to Derivatives

How does Derivative Investment Work?

Investment in derivatives works like a simple sale-purchase transaction with parties involved, such as the buyer and seller. The parties bet against the future price of the underlying asset by selling it at a pre-determined future price and date. Since the asset price keeps constantly changing owing to market fluctuations, it may result in profit or loss for either of the parties.

Let us take a small example to understand how investment in derivatives works:

You are a farmer who wishes to sell two quintals of rice for Rs. 2,000 in the next three months. However, owing to the market conditions, you are unsure if the rice you sell will yield you an amount of Rs. 2,000. So, you enter into a derivative contract with a buyer willing to buy 2 kgs of rice for Rs. 2,000, irrespective of the price change in the future. Thus, you are betting against the price of the asset by trying to minimize your risk. If the value of rice in the next three months goes down, you have earned profit against it. But if the value of rice goes upwards, then you have incurred a loss against it.

Thus, derivate investment could work in favour of either of the contracting parties. It is the buying and selling of assets such as stocks, bonds, commodities, currencies, exchange rates, rate of interest, and market indices at a pre-determined future price and date. Here are the four types of Derivatives that you need to know about:

-   Forwards

-   Futures

-   Options

-   Swaps

Investment In Derivatives: Is Demat account a pre-requisite?

A Demat Account may or may not be mandatory for investment derivatives. It depends on the class of asset you are trading, such as equity or non-equity asset. Let us look at the scenarios where a Demat Account is not required and when it is.

Additional Read: Features and benefits of a Demat Account

• Investment in Commodity Derivatives: You may not need a Demat Account if you look at commodity derivatives. Investment in commodities entails the trading of tangible goods. They are non-equity assets. Examples are agricultural commodities, gold, silver, natural gas, crude oil, steel, etc. Since they are traded in their physical form, a Demat Account is not required for participating in commodity investment. All you need to have is an active Trading Account with a SEBI registered stockbroker.

• Investment in Equity Derivatives: Equity derivates entail trading of stock and market indices. Therefore, it requires a Demat Account linked to your Trading Account. They are actively traded on the exchanges. So, to invest in equity derivatives, you need to have your stocks in a dematerialised form.

Additional Read: Dos and Don'ts for a Demat Account

CONCLUSION:

Having a Demat Account is mandatory when you want to trade in the stock market. It enables you to keep a track of your stocks and, securities held. It keeps an account of the delivery of shares. But it is not always mandatory. It is necessary only when you are dealing with equity assets. If you are dealing with trade of non-equity assets, a Demat Account is not necessary. Non-equity assets mostly settle with cash. If you want to start trading in derivatives, then you should open a Trading and Demat Account with a SEBI registered stock broker.

FAQs:

   1. Is a Demat Account required for Futures and Options?

A Demat Account is required specifically when trading in equities and market indices. This is because a Demat Account is where shares are held in their online form. Any transaction related to equities requires a Demat Account. However, if you are dealing purely in Futures and Options, then the trade may not entail a physical delivery. In such cases, having a Trading Account will suffice. However, it is recommended that you get a Demat Account for any transaction related to equities in the share market.

   2. What is derivatives in Demat Account?

Derivatives are financial contracts that derive their value from an underlying asset. It is an agreement between two parties to buy or sell an underlying at a predetermined price on a date agreed upon in future. A Demat Account is required when you trade in equity derivatives. This is because it may entail physical delivery of shares. Any transaction related to equities requires a Demat Account, as mandated by the SEBI.

   3. What are the rules of derivatives trading in Demat?

A Demat Account is an online account that stores different financial instruments that one owns. Earlier, it was not essential for those trading in derivatives to have a Demat Account. Now, however, the SEBI has mandated that all stock-related transactions are settled physically. This means that for trading in equity derivatives, one must compulsorily have a Demat Account. However, in case you are trading in commodity or currency derivatives, it is not essential to have a Demat Account since these transactions are settled in cash.

    4.  Can Demat Account differ from Trading Account?

A Demat Account and a Trading Account are two different types of accounts required for trading in financial markets. A Demat Account is an online account that stores different types of financial instruments that one owns. A Trading Account, on the other hand, provides the interface or mechanism to trade in financial markets. It is compulsory to have a Trading Account to transact in the financial markets in India. You need to have a Trading Account to buy equities, derivatives, etc. However, a Demat Account is compulsory only for equity-related transactions. A Demat Account is not essential for futures and options trading. A Trading Account will suffice.

Disclaimer : ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Mr. Anoop Goyal, Contact number: 022-40701000, E-mail address: complianceofficer@icicisecurities.com. Investment in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.