What is derivatives trading in stock market
The rest of us, however, are often left on the outside of these conversations, not quite sure what derivatives are or how they might affect us.
Financial derivatives are used for two main purposes to speculate and to hedge investments. Think of it as an insurance policy—farmers purchase derivatives that allow them to benefit if the weather damages or destroys their crop.
If the weather is good, and the result is a bumper crop, then the farmer is only out the cost of purchasing the derivative. Part of the reason why many find it hard to understand derivatives is that the term itself refers to a wide variety of financial instruments.
At its most basic, a financial derivative is a contract between two parties that specifies conditions under which payments are made between two parties. Conditions that determine when payments are made often include the price of the underlying asset and the date at which the underlying asset achieves that price.
A call option gives the buyer of the option the right, but not the obligation, to purchase an agreed quantity of stock at a certain price on a certain date. Call options are speculative, risky investments. You can often be right on the direction that the stock price moves, but wrong on timing.
It can be a very painful lesson to learn. Not everyone is a fan of using derivatives, including investors as regarded as Warren Buffett. Buffett has largely been proven correct in the time since his initial statement, now that experts widely blame derivative instruments like collateralized debt obligations CDOs and credit default swaps CDSs for the financial crisis in In his paper, Derivative Instruments and the Financial Crisis Derivatives may not be a financial instrument that the average investor wants to try on her own, but derivatives can add value to society when used appropriately and in moderation.
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