If you have more or less competence in the world of investment then you have probably heard about the term ‘’finance derivatives’’.
For the people with no idea about this business term we are going to give a definition of it. In the sphere of finance derivatives are considered securities linked to other securities such as stocks or bonds. If you are a newbie in this game it is not advisable for you to deal with this type of investing.
However, if you know this world like a back of your hand then finance derivatives may become the best option for you to test things out and breathe new life into your business.
Types of finance derivatives
Majority of financial engineering strategies suggest three main types of finance derivatives.
- Options: Contracts allowing two parties to sell or buy a security at a certain price are called options. More often than not they are used for trading stock options. However, they may as well be used for other types of investments. For example, if the investor makes up his mind to purchase the right of buying an asset at a specific price, we are dealing with a call option. In case the same investor purchases the right to sell an asset at a certain price, we will see put option in action.
- Futures: Although futures work on the same basis as options the underlying security in this case is quite different. These are financial contracts that oblige the buyer to purchase an asset (it be a physical commodity or a financial instrument) at a predetermined future date and price.
- Swaps: Swaps are derivative contracts that enable two parties to exchange the benefits of their financial securities. Let’s assume that one side has a bond with a fixed interest rate but he needs varying interest rate for good reasons. Here is when this party may decide to enter into a swap contract with his partner for the sake of exchanging interest rates.
Advantages of using finance derivatives
Finance derivatives bring a number of advantages to the investor including but not limited to the following;
- Non-Binding Contracts: Though the investors purchase finance derivatives they are never obliged to exercise their option. So, the investors are given a lot of flexibility in following up their investment strategy.
- Leverage Returns: Finance derivatives enable the investors to make extreme returns, something which is quite impossible in case of primary investments.
- Advanced Investment Strategies: Finally, finance derivatives provide the investors with the opportunity to execute complex investment strategies that can later be used to their own advantage.
Though finance derivatives may become great tools for you to leverage your portfolio and provide you with flexibility of actions you need to be very careful while exercising your options. It’s worth keeping in mind that finance derivatives are risky investments.
It’s true that these are rather volatile investment tools but in the hands of a professional and with the right strategy they may become irreplaceable parts of your investment portfolio.