Hi there! If you’re reading this article, then that must be because you want to learn of Derivatives Investing. People fear the risks associated with the conventional investment methods. Unless you play safe, you get to lose everything, which you had painfully collected throughout the years. Okay, so here is yet another paradigm that can help you become financially stable without losing much from your pockets
That does sound like an interesting proposition; yes, in the remaining sections, we will be dealing with investing on derivatives. As mentioned earlier, those who are unwilling to take their chances can opt to trade using this paradigm. What are derivatives trading? How is it different from the conventional forms of trading – such as the equity trading?
In simple terms, investing on derivatives is akin to making a contract to purchase a commodity or company share at a future date. The buyer does not have to pay the seller anything. All the fiscal transactions occur according to the conditions outlined in the agreement. In order to explain the concept in depth, allow me to introduce a real world example.
For the sake of illustration, consider that you wish to purchase a particular commodity. You can purchase the product from the nearest shop. Alternatively, you can call up the shop and ask them to set aside the product, so that you might purchase it after a couple of hours.
Those who are involved in derivatives trading practice the same strategy. They would reserve shares and securities by paying up a fraction of the original cost. At the desired date, the buyer can forfeit the agreement. At times, the buyer will have to exercise the contract and purchase the commodity at a price. It is possible to speculate the average pricing of the securities and thus outline a contract that suffices the requirements of both the buyer as well as the seller!
Forward contracts, options and swap are important parameters that occur when one invests in derivatives. The product for which the contract has been laid is termed as the underlying. In the same manner, the type of derivatives investment depends upon the nature of the underlying. The trading can take place at an exchange (exchange traded derivative contracts) or over the counter (OTC).
One of the biggest vantages of investing in derivatives is the ability to impart high amounts of leverages. Fluctuations in the value of the underlying can turn out to be advantageous (or disadvantageous) for the investor. The trader will have a complete control over the situation. If the market conditions turn out to be feasible, they will rake in the profits.
On the contrary, if things are not working out as envisioned, there is a provision for the cancellation of the agreement. Thus, the investor is saved from huge losses by paying up nominal amounts. This is alternatively termed as hedging. Do you now realize why the domain is touted to be perfectly free of risks? The niche is interesting, once you get the lay of the land. Do keep us posted with your investment experiences!