Options & Derivatives – Trading Derivatives 101
Derivative instruments are known in the industry as new and interesting ways to deal with money, to say the least. However, such instruments are not new, as they have been used for quite some time and for other reasons than just investing in assets and making a profit out of investing.
This concise review of PF Derivatives shows us that these instruments are basically securities that have an underlying asset. The interesting part is that the latter is the one responsible for the term structure, for the risk of the derivative, as well as for its pricing.
Let’s take a closer look at what it means to trade using these kinds of instruments!
What are Options & Derivatives?
As mentioned above, they are a type of instrument that come in the form of securities. These come with an underlying asset that determines pretty much everything related to that security.
The most important part is that these instruments are not used for direct or easy profit. Instead, they are used to manage positions and create various strategies, to potentially increase certain leverage, or to even engage in predictions regarding the asset price.
Last but not least, it is worth mentioning that these instruments can be purchased on an exchange or over the counter, depending on the contract type – they can be sold using these methods as well.
Types of Trading Instruments
When it comes to type, these trading instruments can be traded in the form of swaps, as options, or as the more complex futures and forwards contracts. Each of them comes with a wide range of variations that the investor must learn before dealing with derivatives. For example:
- Options – these provide one with the right to buy/sell a certain asset but don’t imply obligation. This type is used by investors who don’t want to risk assuming certain positions but would like to see exposure growth. Strategies revolving around options are long call and put and short call and put.
- Swaps – these imply that the two parties exchange certain variables that are associated with various investments. In terms of strategies, we have interest rate, currency, and commodity swaps, as well as the plain vanilla.
- Forwards and Futures Contracts – these imply that the parties engaged in a contract agree to trade the determined asset at a certain time in the future, as a specified, pre-determined price. They are often used to predict price changes or to hedge risk. Keep in mind that forwards are non-standard contracts that are traded over the counter, while futures are standard contracts that can be traded via exchanges.
The Bottom Line
These trading instruments are best used by those that wish to either acknowledge or protect risk in their trading portfolio. Any type of strategies involving this instrument can be used, as mentioned above, to increase one’s leverage, top engage in speculation, and to hedge.
On the other hand, such an instrument is successfully used only if the user understands the risks they might face and acknowledges the fact that they imply the broadening of their strategies and portfolio towards a risky area.