Understanding Derivatives Trading

Investing has become so much more complicated over the last decade. While simple stock buy and keep strategies still work, the investing world now has a lot more vehicles to choose from. Today, we will focus on one of the new trends in investing, which is called trading derivatives.

What are Derivatives?

Derivatives are a special type of investments in which the buyer does not actually own the underlying asset, which might sound weird at first. They make a bet towards the direction in which the price of the good or product will move with another party, usually in a bilateral agreement. There is more than one instrument used to trade derivatives, such as futures, options, swaps and forward contracts. Although derivative instruments carry significand risks, they are seen as a good alternative to participating in the market for different goods or services.


Futures are the most common of these instruments. Simply put, they represent an agreement between two parties to buy or sell a good at an agreed price in the future, based in how that product is doing today. They are especially common in trading commodities and other assets which tend to vary a lot, due to producers being able to hedge some of the risk of a bad crop or bad year.


Options are gaining more and more popularity at the moment, mostly due to two reasons. They offer a (potentially) unlimited win for a set loss and they are very easy to understand. You are essentially betting on where the price of a certain good (stock, currency pair, etc.) will go. For example, if an Apple share is trading for 500$, and you believe it will rise, you can buy a ticket with 5$ that says the stock will shoot up. If it gets to 600$ in a set timeframe, you win 600 – 500 = $100. Be advised, the probability is low. Although this sounds more like gambling then trading, the possibilities options offer are worth investigation


All in all, derivatives offer good diversity to an investment portfolio and can really bring good benefits if you use them correctly. As always, pay attention to leverage and risk and carefully plan each move. The market rewards patience, as it does with all other instruments as well.

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