Derivatives Trading

Derivatives trading is trading based on a financial instrument whose value is based on an underlying asset. As the name implies the price of the derivative is “derived” from the price of another asset.  An example of this would be options on stock. The options value is correlated to the price of the stock. In essence, it’s a contract between two parties with specific conditions. Options on stock gives the buyer the the right to do something and the seller the obligation to do something at a certain price before a certain time.

Many traders hear the term “derivatives trading” talked about in the media with negative connotations. But many don’t realize that options are derivatives contracts and options surely have many benefits to both large institutional traders and small retail trader alike.

Derivatives trading can be used for speculation or to hedge.  An investor can use options on stock to speculate that a stock may take a dive in price. He or she can sell call option in hopes that the right to buy the stock at a certain price will be worthless but then exposes themselves to potentially unlimited losses. Derivatives trading can be quite a desirable asset to a trader but the risk, like any type of trading, needs to be managed. Trader can manage risk by using stops, trading spreads and using sound money management strategies as well.

Since the financial crisis of 2008, financial reforms within the U.S. have reinforced derivatives trading including greater access to government guarantees.

To learn more about derivatives trading like options on stock, please visit us again at optionsblognewsletter.

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Options involve risk and are not suitable for all investors. No statement on this site is intended to be a recommendation to buy or sell securities.