In finance, derivatives are a type of financial contract that derives its value from an underlying asset or group of assets. Derivative products allow traders to speculate on, and potentially profit from, movements in financial markets such as stocks, currencies, and commodities, without having to own the underlying asset. Traders also use derivatives to manage risk and hedge against potential losses.
An option is a contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on a predetermined date. If the contract is not exercised, it simply expires worthless.
A future is an agreement between two parties to buy or sell an underlying asset at a specified price on a predetermined date. Unlike with options, both parties must fulfil the contract when it expires.
A swap is a financial contract between two parties to exchange cash flows in the future. The most common type of swap is an interest rate swap, where one party agrees to pay a fixed interest rate to the other party in exchange for receiving a floating exchange rate.
Traders can hedge existing positions to reduce risk exposure and offset potential losses in their investment portfolio. For example, a stockholder may use index futures to hedge against a potential market downturn without selling the stocks.
Derivative trading can also be leveraged, so traders can control a large position in financial markets with a relatively small starting capital. This has the potential to magnify profits substantially.
However, it can also increase losses, and traders should use leverage with caution.
Finally, derivative products offer traders a way to speculate on future price movements in financial markets without having to own the underlying asset itself. This increases flexibility in trading.
ADSS offers a range of global markets for traders, with opportunities in indices, commodities, forex, equities and more. We also feature tutorials, how-to guides, and weekly webinars to help you navigate the financial markets and find better trading opportunities. You can start trading and investing online by opening a live trading or demo trading account.