The financial market is one of the places you can look into when you want to invest. In most cases to deal in the financial markets, you need to buy the asset to sell them in future if they accrue some value. Among the common types of assets that you can come across include shares, bonds, commodities, and currencies.
However, in some cases you do not need to buy the assets, rather you sign into a contract that binds them. This form of trading is better known as derivative trading.
The Derivative Trading Concept
In derivative trading, you buy into a contract that tracks the value of underlying assets. This is a form of trading that has graced the stage for ages and acted as insurance against losses in the market. The contract is between two or more parties with a binding agreement in the price change.
Derivative trading can be done over the counter or from an exchange platform such as a major stock exchange. The deal is mainly based on speculation with the gains or losses coming from the price fluctuations of the underlying asset.
There are several types of derivatives you can bank on in the financial market as summarized below.
Forms Of Derivative Trading
Options trading is a common form of derivative trades where the contract offers you as the buyer an option to buy or sell though it is not an obligation. This depends on the contract type that you hold where you can opt for call options or put options.
Call options allow you as the contract signatory to buy the underlying asset at the quoted price in an agreed-upon period. Put options, on the other hand, allow you to sell the asset, also at an agreed period. The options are commonly traded over the counter though many online brokers offer the exchange service.
When you decide to take options as your preferred trading instrument, take note of the expiry date. When going for call options, the assumption is the price of the underlying asset will appreciate and you can buy the asset at the initial strike price and sell it for a gain.
Going for put options is akin to going short in the market. Here you expect a price drop on the assets hence you sell them at the strike price to an interested party. At the expiry of the timeframe, if there is a price drop, you purchase the assets back at the new price which is lower to replace them.
For both call and put options, you need to factor in the expenses.
Trading in futures is another form of derivative trading. When dealing in futures, you get into a contract involving the purchase and delivery of an asset at a particular date in the future. Its basis comes from the speculation of prices hence the parties in the contract want to shield themselves from speculative losses.
Here you may purchase a commodity keeping in mind that the market has been fluctuating and the prices may increase. The increase will force you to spend more on purchasing the asset. As a seller, on the other hand, you sell the asset at the initial price fearing for a price drop in the future that may plunge you into a loss.
Alternatively, as a seller, you may go short on the security and sell it then wait for a price drop to get it again and refill your stock base. The difference between the selling price and the buying price is your gain.
Derivatives trading is one way you can get invest in the financial market without initially purchasing assets. Most economist look at it as a form of gambling which is true for most investments. As an investor, you need to look at it as a form of hedging or insurance to shelter you against an unforeseen loss. Apart from options trading and futures trading, there are also swaps and forward that you can look into if you want to try out the derivatives market.
Hey, I am Raj. I am the owner and content publisher at Financenize. I have completed my education till intermediate school and after that turn to a full-time blogger and content writer. I usually share the quality information for the readers in Financenize, which helps the small business, individuals and entrepreneurs and the information I share makes their task more manageable. I am expert in analyzing the current situation and deliver a profitable period to the extent. You can find me on various social media handles online.