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Find out about news, analysis, trends in financial markets and potential opportunities. Arise Academy uses its collective knowledge to show you the most relevant information of the moment.

estimated reading time: 8 minutes

⦁    INTRODUCTION
⦁    What are derivatives?
⦁    Why using derivatives?
     ⦁    Hedging
     ⦁    Leverage
     ⦁    Speculate the price of an Asset
⦁    #1 CFDs
     ⦁    What are CFDs?
     ⦁    How do CFDs work?
     ⦁    Advantages
⦁    #2 Futures
     ⦁    What are Futures?
     ⦁    How do Futures work?
          ⦁    Regulation of Futures
          ⦁    Tick Value
⦁    #3 Options
     ⦁    What are Options?
     ⦁    Types of Options
     ⦁    Value of an Option
⦁    Conclusion

 

Trading markets constitute a huge cybernetic world where traders and brokers interact financially to buy or sell product and services. However, is that all they can do? 

Many do not know, but there are more to learn than just currencies, bonds and stocks; that is where DERIVATIVES come in. Derivatives are an unfamiliar concept to general audiences, and yet an important topic to discuss and learn from.


WHAT ARE DERIVATIVES?

A derivative represents a contract between two parties whose value depends on or fluctuates according to an underlying asset and its value, such as stock, index, bond, interest rates, currency, or commodities markets.


WHY USING DERIVATIVES?


Derivatives have many ways to be used, and these are:

⦁    HEDGING

Hedging works as a risk management strategy focused to minimize the risk of unfavorable movements in the price of an asset by taking an opposite position in that particular asset. In other words, it offsets losses in investments.

By reducing the risk applying a hedging strategy, profits are frequently reduced as well.

Derivatives work comfortably with hedging strategies due to their skills to provide traders real profits from ‘short-selling’ movements.


⦁    LEVERAGE

Leverage grants traders the opportunity to open a position by only paying a percentage of its cost. Due to this, a trader is able to gain wider exposure in a market whose capital is higher than the trader’s investment capital.

Leverage is an investment strategy that consists in borrowing money from various financial instruments (or borrowed capital) to increase the possibilities for an investment to return.

Traders who apply a leverage strategy are allowed to increase their potential profits as their starting capital remains the same. However, it also increases the possibilities to amplify your losses. Be careful.


⦁    SPECULATE THE PRICE OF AN ASSET

In this case, speculation regards the attempt to make profits out of a security’s price change. In other words, it represents the purchase of an asset hoping to become more valuable in the market in a period of time.

Speculation is driven by the motive of potentially earning lucrative profits in the near future.

Now that you know what derivatives are and their purpose in the trading market, take a look at the top 3 must-have derivatives of 2020:


#1 CONTRACTS FOR DIFFERENCE (CFDs)


What are CFDs?

 CFDs are arrangements between two parties: a buyer and a seller. All financial moves relay on spreads prices and values at a specific time. A seller requires paying a buyer that spread between a stock price and value if the value rises.

CFDs have become the favorite for many traders, and it is one of the most acclaimed forms of financial derivatives out in the market in 2020.

    How do CFDs work?

CFDs allow traders to enter into a contract with a broker whereby they agree certain terms to exchange the difference in price of an asset between the date where the contract starts and ends.

Usually, the contract remains active as long as none of the parties close it. If there is insufficient equity in the trade being held, the broker is allowed to close it.

    Advantages

A huge advantage CFDs offers to traders is to be able to gain profits whether the market increases or decreases the price by ‘long-selling’ and ‘short-selling’.

Generally, a CFD owns less rules and regulations in the market. Thanks to that, CFDs can have lower capital or cash requirements in a brokerage account.


#2 FUTURES


    What are Futures?

 In this case, a future is a derivative financial option where contracts obligate the parties: a buyer and a seller, to exchange an asset on a future specific date at a fixed price. 

    How futures work?

Futures concede traders to lock in a price of the underlying asset or commodity, and the buyer must purchase or the seller must sell the underlying asset at the set-up price no matter the fluctuations in the market at the expiration date.

⦁    REGULATION OF FUTURES

This kind of derivatives is regulated by the Commodity Futures Trading Commission (CFTC). It regulates brokerage firms which are engaged in futures trading, also ensuring the integrity of futures market pricing and prevents abusive trading practices.

⦁    TICK VALUE

Future contracts are represented by one element: the tick value. A tick is the minimum price fluctuation at any given moment in the day.

A tick constitutes a monetary gain or loss to the traders holding future contracts, and these ticks are different for every future contract. 

#3 OPTIONS

    What are Options?

 Finally, options give traders the benefic to hedge risk or to speculate by taking additional risk. These are ‘options’ to buy or sell, opposite to futures which represent a certain obligation matter.

    Types of Options

Commonly, the most familiar types of options are:

⦁    CALL OPTIONS: these options allow their owner to purchase an asset at a set price in a specified timeframe; specifically European or American.

⦁    PUT OPTIONS: these options allow their owner to sell an asset at a set prince in a specified timeframe; specifically European or American.


Value of an Option

These values are categorized as:

⦁    TIME PREMIUM: where decays as the option’s expiration date approaches, eventually becoming meaningless.
⦁    VOLATILITY: of the stock or contract
⦁    INTRINSIC VALUE: it varies depending on the price of the underlying security.


CONCLUSION


As confusing as it might seems, derivatives are fundamental in the stock market. Whether you decide to learn from them or not, they constitute an important role in trading.

2020 has been a difficult year for everybody, but online investments have risen like never before. So, consider starting to trade working with any of these strategies: CFDs, Futures or Options. Different from each other, these derivatives alternatives would make you gain real profits if done correctly.