Derivative Contracts


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Derivative Contracts

Derivative contracts are agreements by which a trader gains leverage on investments in underlying financial instruments such as stock shares. Derivative contracts derive their value from the underlying instrument. However, they offer the opportunity for greater profit, the option to buy stock or sell stock at a given price, the possibility of hedging risk, and the possibility of trading where there is no underlying financial instrument. Derivatives contracts include those used in trading options, futures, commodities, foreign exchange trading, interest rates, or credits.

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Derivative Contracts

  1. 1. Derivative
  2. 2. Derivative contracts are agreements bywhich a trader gains leverage oninvestments in underlying financialinstruments such as stock
  3. 3. Derivative contracts derive their valuefrom the underlying
  4. 4. However, they offer the opportunity forgreater profit, the option to buy stock orsell stock at a given price, the
  5. 5. of hedging risk, and the possibility oftrading where there is no underlyingfinancial
  6. 6. Derivatives contracts include those usedin trading options, futures, commodities,foreign exchange trading, interest rates,or
  7. 7. Derivative contracts can be complex(exotic) or they can be simple (vanilla)
  8. 8. The underlying features that all have incommon is the ability to gain more profitand to have more choices at a
  9. 9. The risk with these contracts
  10. 10. For example, buying calls in optionstrading gives the buyer the option to buy100 shares of stock per contract on orbefore a given date, the contractexpiration
  11. 11. Traders will pay a premium for thisopportunity and will exercise optionscontracts, the derivatives, if the stockprice goes up enough to make a
  12. 12. On the other hand selling calls gains thetrader a premium but gives away theopportunity for substantial profits if thestock price goes up
  13. 13. The risk involved in derivative
  14. 14. In fact, many trade derivatives as part ofa hedging strategy while others engagein options trading and futures tradingwith potentially unlimited
  15. 15. An example of trading derivatives toreduce investment or business risk is
  16. 16. gold mining company selling futures ongold at a price below the current
  17. 17. The company guarantees themselves aprofit on part of their
  18. 18. This trading strategy can be used byinvestors in the company as
  19. 19. Those engaged in long term investingcan also take advantage of
  20. 20. A common tactic is the use of coveredcall
  21. 21. An investor who is familiar with thesupport and resistance zones of one ofhis cyclical stocks can profit by sellingcovered calls when the stock is at thetop of its traditional trading
  22. 22. The investor gains the premium,offsetting his portfolio loss, while thestock cycles down in
  23. 23. Another covered option is buying putson a stock that has recently run up
  24. 24. The stock owner pays a little insurancein the form of the
  25. 25. If the stock corrects substantially he orshe will then exercise the put options,sell at the strike price, and buy again atthe new, lower, spot
  26. 26. Managing risk in trading derivativecontracts is
  27. 27. Selling uncovered call options oruncovered put options opens the traderto potentially huge risk if the underlyingfinancial instrument goes updramatically in
  28. 28. This sort of trading in derivatives isstatistically very
  29. 29. That is why large institutional traders
  30. 30. The problem for the individual investoror trader is that every so often the tradegoes bad and there is a price to
  31. 31. Large institutions can handle the cost.Most individual investors cannot andshould typically avoid trading where thepotential for loss is
  32. 32. Online Stock Market Reviews presentedlive via the internet by Stephen