Why or why not invest in derivatives?
Are you thinking about investing in derivatives? First of all, you need to understand what derivatives are . What are the advantages and disadvantages of them?
Derivatives are financial products that derive their value from the product from which they are derived. The underlying value determines the price. Traders often use derivatives as a means to speculate on the upcoming price movements of an asset, without buying the underlying asset itself (such as a share). This can be done in both rising and falling markets.
Contract
When derivatives positions are opened, no physical assets are traded. As a result, derivatives are often a contract between two parties. These contracts are traded on a stock exchange or over the counter. Derivatives make it possible to trade in a variety of underlying assets, from shares and indices to forex, bonds and commodities.
Popular derivatives
There are many derivative products to choose from if you are interested in this way of investing. The most popular derivatives are options and CFDs , which stands for contracts for difference.
When you trade in CFDs, you never own a property, but speculate on the underlying price. The contract is concluded between the broker and the investor. You do not get the underlying value in your possession, but the right to profit in case of price gains. This also means that you have the obligation to pay in case of price losses. The contract that is drawn up does not have an end date. This means that it can be drawn up entirely based on your own objectives.
Options give you the right, but not the obligation, to buy or sell the underlying asset at a certain expiration date. Options also allow you to speculate on the future price of a financial instrument.
Other examples of derivatives you may be familiar with are turbos and futures contracts .
Advantages of derivatives
There are several advantages to trading derivatives. For example, it is often used for hedging. By means of hedging, you can minimize (the risk of) losses on other positions. Because derivatives offer more flexibility when compared to directly trading the underlying values, derivatives are very suitable for hedging.
In addition, you can open a short position with derivatives. Where investors usually open a long position by buying an asset and hoping that it will increase in value, you do the opposite with shorting. Here you speculate on falling prices.
Some online brokers allow you to trade derivatives on margin. This means that you only have to deposit a small part of the total value of the position. You borrow the other part from the broker, as it were. Because the profit on the position is calculated based on the total value of the transaction, this can be very lucrative. However, this is only recommended for experienced traders. Conversely, it is also true that trading with leverage increases losses. It is therefore extremely important to be able to properly estimate the loss potential of the trades. Read more about the risks of derivatives .
Disadvantages of derivatives
Derivatives make it possible to speculate on price increases and decreases. It is said that derivatives can promote market volatility. For example, speculators have been suspected in the past of causing large fluctuations on the stock market and filling their pockets during periods of rising food and fuel prices. The danger of price movements that are further fueled by speculation is that speculative bubbles are created. This in turn causes the intrinsic value of an asset to exceed the actual market price. The bursting of such a bubble has far-reaching consequences for markets and even economies. We all remember the year 2008, when the American housing bubble burst. This had an impact on the entire global economy.
Trading in derivatives
Are you excited about investing in derivatives after reading this blog? Then check out all the brokers that offer derivatives and start comparing!
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