World of Trade: The 4 Major Kinds of Derivatives You Need to Know!

The world of trade is vast and the markets are broadly grouped into metals, commodities, forex, digital currency and even derivatives. As a starting trader, you can venture into these market groups and trade with assets in one of two ways: tangibly or intangibly.

All trades can be traded intangibly and this is called derivatives. This is used by traders to simply buy and sell assets by their underlying security. So basically, you don’t own anything physically.

There are 4 kinds of derivatives in trade and if you’re curious about what they are and how they work, consider checking out everything there is to know about them down below!

What are the 4 main derivatives?

Once you get into trade, you’ll surely come across these 5 derivatives since they are fairly popular in any market. These trades are Options, CFDs, Single Stock Futures and Warrants.

All these hold different purposes, functions, objectives and processes. To know each one, down below is a rundown:

What are Options in trade?

Options trading is a contract given to a trader. By signing this agreement, the buyer acquires the right to purchase and sell the underlying asset on or before a given date. And note, traders are not obligated to own the underlying asset to buy or sell an option.

There are four ways to trade with options: sell a call option, buy a call option, sell a put option and buy a put option. In trade, when you buy you believe that the value of a certain asset will increase, selling means you think it won’t.

What are the pros and cons of options trading?

To have a funny grasp of what options trading is, you must know its pros and cons!

Pros of options trading:

• It has a high return value potential.
• It’s cost-efficient.
• It has lower risks compared to other derivatives.

Cons of options trading:

• You have to consider time decay.
• It’s less liquid than other derivatives.
• Limited options when it comes to stocks.

What are CFDs in trade?

CFD stands for Contract of Difference. This is an agreement between a seller and a buyer where the seller stipulates that if the value of the stock increases after the contract is signed, the seller must pay the buyer the difference between those two values.

And if the spread is negative, the buyer has to pay the seller. CFDs are arrangements made in future contracts and the difference is paid in cash. CFDs can be found in every trade may it be metals, forex, stocks, bonds, indices, commodities, digital currency and more.

It’s a kind of advanced strategy that is usually taken on by more experienced traders.

What are the pros and cons of CFD trading?

To know if CFD trading is for you, here’s a list of its pros and cons to know this trade better:

Pros of CFD trading:

• CFD trading provides traders with high leverage. Your $1 can become a whopping $50!
• Provides professional execution with no added fees.
• You get a wide variety of trading opportunities like metals, stocks, indices, commodities and more.

Cons of CFD trading:

• It has weak industry regulations.
• Traders are the ones who pay for spreads. Which can ultimately affect your overall income.
• High leverage also means high risk. Your $50 can instantly turn into a $1.

What are single stock futures (SSF) in trade?

SSFs are standardised contracts between two parties: a buyer and a seller that agree on shares that will be sent to the buyer at the contract’s expiration. The basis of the SSF market price is the asset price multiplied by the interest-bearing cost, less any dividends received over the contract duration.

What are the pros and cons of single stock futures?

To better understand SSFs, you need to know their set of advantages and disadvantages!

Pros of SSF trading:

• You can start small and profit big with its leverage!
• You have the ability to short trade.
• Low commission fees!

Cons of SSF trading:

• The risks are exorbitant since you’re facing high leverage.
• It has a low trading volume.
• You have no actual ownership.

What are warrants in trade?

A stock warrant signifies the right to buy shares of a corporation at a certain price and on a certain date. Call warrants and put warrants are the two primary categories of warrants. Warrants, just like call options, are exercise stock at a fixed price.

A warrant has a long exercise time before it expires, but its price when it is first granted is always more significant than the stock it supports. Normal exchange trading of stock warrants might have low volume, which increases the risk of liquidity.

What are the pros and cons of warrants?

To understand warrants better, you need to consider knowing their advantages and disadvantages.

Pros of warrants:

• Holders of warrants have the option, but not the obligation, to buy shares of stock.
• Investors may be given the option to purchase stocks at a price over the going market rate.

Cons of warrants:

• High in volatility and can greatly affect price value over time.
• Prone to dilution when new shares are issued and a warrant is exercised.

What is the differentiation rule of derivative trading?

Differentiation rules are essential when trading with derivatives. These rules help traders evaluate the function of certain derivatives. There are 5 differentiation rules: Power Rule, Product Rule, Sum and Difference Rule, Chain Rule and Quotient Rule.

Take away

Now you know the 4 major kinds of derivatives, you can now make a more accurate decision when choosing. All you have to do now is to pick one with pros that weigh out the cons.

Derivatives are great since they allow you to profit from underlying assets. This means you don’t need to take any physical ownership of an asset when trading. No physical ownership means no need for storage.

So you can simply make a quick buck without the hassle of handling the assets. All you need to do is invest with a brokerage. All the more reasons why derivatives are a go-to for all sorts of traders.