What is a derivative? The term derivative is used to mean futures, options and commodities. It could also be said as financial investments by which the value is generated (or derived) from performance of another security (for example; stocks or bonds).
Let’s say you heard an advertisement talking about the possibility of oil prices rising. Due to whatever events in the world that are happening, they have caused the oil prices to rise and will continue to do so, according to the news or advertisement. You are interested. So you call the number provided by the advertiser.
What now? You are convinced and think the idea of buying oil for the current price sounds profitable. You buy the futures from this company with a value of $20,000.
You should know that buying futures can be said to be similar to gambling. It has much high risks when you are investing in futures. Why is this so? The answer is futures work on a short-term basis. And we all know that short-term things carry a certain amount of risk. Price of oil can move up and down anytime within a week. This is why buying futures is compared to gambling your money at the poker table.
What about options? They are as risky as futures also. It involves short-term to work. However, there is one way in which you can make a huge profit by investing in options. That is of course, getting a spy (from the company itself) to expose to you the company’s next major movement – be it investments, acquiring a new technology patent or entering the next phase. As good as it sounds, you can end up in prison if you are caught doing this.
The stock market is a very dangerous place. The same goes to bonds and mutual funds and commodities. As described earlier, options and futures are both related to the stock market in which “fast money” is involved. If you decide to go into stocks, then make sure you get an honest broker. There is simply no other way. Remember that for a dollar you make, someone else loses a dollar.
On a side note, futures and options are sometimes used by real world professional investors to make profits in a safe way. How do they do this? They use futures and options to hedge (or reduce their risks) their broad investment holdings.
In conclusion, the investment methods described above are all very risky. It is best that you don’t invest into them, especially if you are new to derivatives.