Derivative Trading is a form of investment that allows you to participate in market movements without owning the underlying asset. It is also referred to as “arbitrage trading” and is a way of exploiting price differences between two markets. Unlike equities, this type of trading does not require you to own the underlying asset.
Derivatives have many benefits, but they are not suitable for beginners. Leverage can greatly magnify your profits or losses. Although leveraged investments are risky, it can also help you hedge a position. Derivatives are usually written for lots of 100 shares. For example, an options contract to buy 100 shares of the S&P 500 index fund might trade for $2.
Speculators in the derivative market are the risk takers. They have the opposite point of view from hedgers and can earn a large profit if their bets are correct. For example, if a hedger buys a put option to protect against a fall in the stock price, the hedger’s counterparty will bet that the price of the stock will not fall. In this case, the hedger will not exercise the put option, which allows the speculator to keep the premium and make a profit.
The primary advantage of using derivatives is that they give you exposure to an individual security or a broad market. The investor buying a put option can protect a gain that he has yet to realize. As with other investments, the risk of losing money is much higher with derivatives. It is important to know the risks involved in derivative trading before jumping in.