Derivatives Market
The derivatives market involves the trading of financial instruments that get their value from another asset. The value is derived from the underlying asset. Basically these are options and futures, the value of which is determined primarily from the value of the commodity or the stock for which they are being used. Most people stay away from derivatives because they think they are too risky. However this is not necessarily the case.
The derivatives market basically consists of two different kind of instruments, futures and options. A futures contract allows you to buy and sell the underlying asset at the price established in the contract for delivery on a specified date in the future. This is done primarily in the commodity market so that the producers and the users of the commodities can know the price ahead of time and plan accordingly. However this also gives speculators the ability to make money. The speculator can make money from the fact that the value of the underlying asset will change before the delivery date. For example if you are a buyer and the price goes up you will make money because the commodity is now worth more than you paid for it. Conversely if you were a seller you can make money because you can buy the commodity that you need to deliver at a lower price than you sold it for.
The other instrument traded as derivatives are options. These are much more complicated than futures. Options are widely traded not only on commodities but also on stocks and currencies as well. When you are trading options you are buying or selling the right to buy or sell the underlying asset at a certain price at a certain time. A call option is the right to buy a put option is the right to sell. Options strategies are very complex and the whole system uses its own terminology that you will have to learn if you want to get in involved. Options are widely used because they allow you to manage risk. You can use them to reduce the risk on a transaction or you can take on a great deal of risk in order to make a larger profit.
Derivatives trading is a lot different from most other forms of investing. First of all because it really isn’t an investment. Most transactions are of a short term nature and are more about speculating than investing. A lot of people stay away from the derivative market because they don’t really understand how it works. While it is true that most derivative traders are specialists who focus exclusively on trading them there is no reason the average person can’t get involved. It is simply a matter of putting in the effort to learning how they work. Used correctly derivatives can be a great way to manage the risk that you are taking when you invest your money.