Hi there! If you’re reading this article, then that must be because you want to learn of Derivatives Market. A derivative is a financial instrument that derives its value from an underlying asset. The most common derivatives investment are options and futures. For example a stock option would derive its value from the stock that underlies it. Derivatives are a relatively new form of investment and in recent years they have started to become somewhat controversial. Derivatives have been largely blamed for the recent financial meltdown. Although they are not entirely to blame they did play a large part in it.
Up until the nineteen seventies derivatives really didn’t exist but when they came onto the market they instantly became very popular. Initially they were introduced to improve the liquidity of the markets however they soon went far beyond that. For example derivatives on stocks now trade many times as much every year as the stocks that underlie them.
This in itself is a problem since money that goes into derivatives isn’t constructive. Buying stocks helps companies to grow so they hire more people and the economy grows. Money that goes into derivatives does nothing to help grow the economy. The other problem with derivatives is that the rules governing them are far more lax than for things like stocks. In fact a lot of people believe the popularity of derivatives is largely based on the fact that traders can do things that they wouldn’t be allowed to do with stocks.
There are derivatives on almost anything, stocks, currency, commodities are the big ones. A futures contract requires the seller to deliver a certain quantity of the underlying asset on a certain day at a certain price. The buyer is obligated to buy the asset at that price on the given date.
Of course most traders don’t actually want the asset, so they have to make sure that they close out their position before the contract expires. They do this by making sure that they sell the contract to somebody who actually wants to take delivery of the underlying asset. Futures contracts are not nearly as complicated as they seem although often the terminology can be confusing.
The other major derivative is the option; these are much more complicated than the futures. An option gives you the right to buy or to sell an asset for a given price at a given date. In exchange for this you are required to pay a premium or you may be paid a premium. The biggest difference between an option and a future is that you don’t have to exercise your option. If you chose to you can let your option expire worthless and not have to take delivery of the asset.
There are two different varieties of options puts and calls. Calls give you the right to buy an asset at a given price while puts give you the right to sell at the given price. Options can be very complicated and there is a lot to learn before you start trading them. It is a good idea to make sure that you are very familiar with how they work before you dive into the market.