Derivatives are financial instruments whose prices originate from the actual value.
Or offered value or the value of some traded assets.
Trading assets include bonds, options, shares and futures contracts.
This derivative instrument is for diversifying risk, and also for speculative purposes.
Purchasing this type of instrument usually uses leverage, so investors can buy derivative instruments for prices that are far higher than the funds they have.
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Financial derivatives meaning
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Derivatives are derivative securities of “main” securities, both in the form of participation and debt.
Derivative effects can mean derivatives directly from the “main” and subsequent derivatives.
Derivatives are contracts or agreements whose value or profit opportunities are related to the performance of other assets.
These other assets are referred to as underlying assets.
In a more specific sense, derivatives are financial contracts between 2 (two) or more parties.
To fulfill the agreement to buy or sell assets/commodities that are used as objects traded at a time and price which is a mutual agreement between the seller and the buyer.
The main instrument in the spot market greatly influences the future value of the trading object.
As an illustration, maybe you have heard of gold investment or offered a gold investment with a yield of 20% per year?
When a sales agent visits you becomes confused, how can you buy and sell gold but see the graph?
Now that is an example of a gold derivative product. The main effect is gold physic. The derivative effect is a gold trading contract. So what is being traded is a gold contract, not real gold.
Potential Risks and Yields of Derivative Investment
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Derivatives are at a high level of potential risk with high returns.
The thing to remember is that potential risk is not the same as risk.
Derivative investment products do have a high-risk potential, but as a trader may choose whether to be a person having the courage to take risks or not.
Because this is a challenge for traders speculators, with high potential and risk, a trader may benefit and may even face a loss.
Examples of Derivative Investment Products
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In general, derivative investment products can be divided into two, namely:
- Derivative investment products sold on the exchange or the secondary market (on the market).
- Derivative investment products that are sold outside the stock exchange (over the counter), so go directly to the person or entity concerned.
Options can be interpreted as choices. The definition of an option is a contract that gives rights (not obligations) to the contract holder to buy or sell an asset at a certain price and for a certain period of time.
This option is usually in the real world in the practice of buying and selling houses.
As an example, Mr. Jonas sees a boarding house that is sold by the owner for $ 4,000,000 Then Mr. Jonas went to the seller to buy options.
The option contains Mr. Jonas given the right to buy the boarding house at a price of $ 4,000,000 in the next 3 months.
The option was purchased by giving money of $ 5,000 (it can be said as a collateral form that can be forfeited).
The $ 5,000 will be forfeited if Mr. Jonas canceled buying the seller’s boarding house.
The consequence of this option is that within the next 3 months the seller may not sell the house to anyone other than Mr. Jonas.
Will Mr. Jonas execute the options or not? Decisions are made in accordance with existing conditions. For example, there are 2 conditions as follows:
Mr. Jonas then looked for other investors that were interested in a boarding house business and were willing to pay an of $ 6,000,000.
Then Mr. Jonas bought the seller’s boarding house for $ 4,000,000.
Mr Jonas total expenditure is $ 4,000,000 + $ 5,000 (option fee).
Then the boarding house is sold to investors.
Mr. Jonas did not find an investor and in the next 3 months did not get any buyers who would buy more than $ 4,000,000.
Then Mr. Jonas does not need to execute the options he has bought from the seller.
In the case above the basic asset is the house, while the derivative is options trading.
Future and Forward
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Future and Forward Contracts are contracts that give obligations to contract holders to buy or sell an asset at a certain price and within a certain period of time.
Future and forward concepts are the same as bonded labor, (sell prematurely).
The difference between futures and forwards is: futures are usually done on the exchange, whereas forwards are usually done directly to the parties concerned.
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SWAP is basically a contract that contains an exchange. What can be exchanged depends on the discussion.
Example of a SWAP contract: there are two parties who each have a loan with the same amount of money.
The first party has a loan with a floating rate or variable rate while the second party has a loan with a fixed rate.
So in this case, the value of the loan will different although having an equivalent amount of debt.
Derivatives market how it works
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Some companies use derivatives to hedge in the future.
Fluctuations in interest rates that can change at any time make banks use derivatives to overcome these conditions in the future.
At the highest level, oil prices will affect airline spending, using these derivatives they choose low prices now to protect against future oil price rises.
Like Southwest Airlines trying with many things to lock in oil prices up to $ 10 per barrel even if prices have risen to more than $ 100.
Some companies even use derivatives to protect themselves from storms and other extreme weather conditions.
Call options, stock options, are also considered derivatives because they give the buyer the right, but not the obligation to buy shares, let say at a fixed price.
Many farmers in America use trading derivatives to protect agricultural prices.
By selling futures contracts based on commodity exchange through a broker.
They can sell their crops at a fixed price even though they have not yet harvested or planted.
So that later farmers will receive the amount of payment in accordance with the agreement contract.
The condition of the price of the harvest that is bound by a futures contract will determine whether the contract produces or actually loses money.
For example, the value of a coffee futures contract gets its value from the current price of coffee beans.
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Another example is currency derivatives.
Some companies may enter into derivative agreements with reference to agreements to buy or sell currencies at a fixed rate at a certain time in the future.
Trade this way with Over The Counter. By engaging in an advanced exchange rate agreement, an entity or agent locks in the exchange rate to be used in the future.
Thus when it is due and the company uses the previously agreement exchange rate, even though the exchange rate when maturity rises high.
Derivatives trading for beginners
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How workings of derivative trading differ from trading in other types of securities because derivatives are based on promises.
For example, if someone buys options on a stock, they do not trade the stock with someone at this time; but they buy the right to buy or sell it in the future.
Option buyers need to know that on the other hand there are people who will buy.
Therefore, the derivatives exchange has a system to ensure that those who buy and sell contracts will be able to do it when they have to sell.
How to trading derivatives
The margin on the derivatives market is money that you must pay as collateral to ensure that you will enter into a contract when it is time to execute it.
On the stock market, margins are collateral for loans from brokerage firms.
Unlike in the derivatives market, the margin is collateral of the amount you have to pay on the contract.
The more likely you are to pay the party buying or selling the contract, the more margin money you will have to spend.
Some exchanges prefer to use the term bond performance rather than margin.
For derivative trading, you put margin with an exchange clearinghouse.
So the exchange knows that you have money to make a deal.
Your brokerage company arranges a deposit.
Your contract will be revalued later.
The exchange will credit the profit to the merchant’s margin account, and reduce if it gets a loss.
If the margin falls below the required amount, the trader gets a call and must deposit more money.
Tips Before Start Derivative Investment
Before investing in derivatives, it’s a good idea to fulfill your homework, which is an effort to improve 3E’s abilities: education, experience, and excessive money.
Derivative investment is indeed quite confusing and is included in investments with high potential risks and high potential returns.
Before investing in derivatives you should get the convenience of investing in derivatives, improve education, experience.
And most important is safe your overall finance for family, just spent money that affords to lose.