Derivatives

Derivatives are financial instruments whose value are dependent on or derived from the price of some other underlying asset (usually bond, currency, equity or commodity). Options, futures, forwards and swaps are some of the common form of derivatives. Most of the derivatives are characterised by greater leverage.

Derivatives are mainly used to reduce the risk of an investor in exchange of providing the potential for greater return to another investor at higher risk. Derivatives like options are traded on margin. This means while trading such a derivative, an investor do not have to fork out the total cost of investment upfront. Instead of doing that, he can use the borrowings to get a better exposure. This is why the level of profit or loss involved with the trading of derivatives is much heftier in comparison with other investments.

Sometimes experienced traders trade derivatives to deal with the risk that is involved with the underlying security in an attempt to remain safe from the instability of the price or simply to make profit from periods of decline or inactivity. However, although trading derivatives can turn out to be profitable, the techniques of trading such financial instruments can involve significant amount of risk.