Financial Derivatives

Financial Derivatives trading

What are financial derivatives?

Introduction

With trading becoming more common and more accessible to everyone who has an interest in financial activities, it is important that information will be delivered in abundance and you will be well equipped to enter the global markets in confidence. Financial derivatives have been in the markets for a long time, also known as common derivatives, they are just easier to access nowadays via online trading.

What is a financial derivative?

The easiest way to explain a derivative is that it is a contractual agreement where a base value is agreed upon by means of an underlying asset, security or index. There are many underlying assets that are contracted to various financial instruments such as stocks, currencies, commodities, bonds and interest rates.

Types of Derivatives:

There are a number of financial derivatives that are offered either OTC (Over-the-counter) or via an Exchange. Derivatives values are affected by the performance of the underlying asset or as mentioned contract.

The more common derivatives used in online trading are:

CFDs

Popular among derivative trading, CFDs enable you to speculate on the increase or decrease in prices of global instruments that include shares, currencies, indices and commodities. CFDs are traded with an instrument that will mirror the movements of the underlying asset, where profits or losses are released as the asset moves in relation to the position the trader has taken.

Futures contract

Common derivatives based on an agreement to buy or sell assets such as commodities like sugar or shares paid for at a later stage but with a set price. Futures are standardized to facilitate trading on the futures exchange where the detail of the underlying asset is dependent on the quality and quantity of the commodity.

Forward contracts

Financial instruments that are set up with more of an informal agreement and traded through a broker that offers traders the opportunity to buy and sell specified assets such as currencies. Here too a price is set and paid for on a future date.

Options

Trading options on the derivatives markets gives traders the right to buy (CALL) or sell (PUT) an underlying asset at a specified price, on or before a certain date with no obligations this being the main difference between options and futures trading.

Swaps

Another common derivative used in a contract setting when trading are swaps, they allow both parties to exchange sequences of cash flows for a set amount of time. They are not exchanged or traded instruments but rather customized OTC contracts between two traders.

Why trade financial derivatives?

Originally derivatives were used to ensure there would be a harmonious balance in exchange rates for goods and services traded on a global scale. Traders found that with differences in currencies and accounting systems it would be easier for traders to find a common derivatives market.

Nowadays, the main reason for derivatives trading is for speculation and the purpose of hedging, as traders look to profit from the changing prices of the underlying assets, securities or indexes.

Derivatives come in several different forms, such as the kinds used for hedging or minimizing risk. For example, a trader may want to profit from a decrease in an assets selling price (sell position). When he inputs a derivative used as a hedge it allows the risk associated with the price of the underlying asset to be transferred between both parties involved in the contract being traded.

Derivatives trading with AvaTrade:

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