DEFINITION of derivative
A derivative is a financial product that enables traders to speculate on the price movement without purchasing the assets.
WHAT IT IS IN ESSENCE
There is nothing physical being traded when derivative positions are opened. So, they usually exist as a contract between two parties.
In other words, a derivative is a financial security. With a value that is reliant upon or derived from an underlying asset or group of assets.
The derivative itself is a contract between two or more parties based upon the asset or assets. Its price determines fluctuations in the underlying asset.
Most derivatives involve margin trading. And offer a larger amount of flexibility when it comes to using different trading strategies across a variety of asset classes.
They give the opportunity to trade on volatility itself, instead of relying on positive moves in an asset’s price.
Derivative products have many forms, with huge differences between them. Some of the major derivatives used by traders are:
- Spread betting. This enables a trader to place a bet on the movement of a market. And with the level of profit or loss defined by the amount the market moves before the position is closed
- CFDs ( contracts for difference). It is an agreement between two parties to pay the difference in price of an asset. Between the time of opening and closing some position.
- Options. It gives traders the right but not the obligation to buy or sell an asset at a certain price within a certain timeframe
HOW TO USE
Derivatives can either be traded over-the-counter (OTC) or on an exchange.
This is the financial instrument whose value comes from an underlying asset. In an underlying asset may be share, commodity, currency, interest rate. This is the contract with a flat maturity date.
In a derivative, the market participants are known as a hedger, arbitrage, and speculator. The main purpose of derivative trading is to avoid future risk of price uncertainty.