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Should I be trading derivatives?

Should I be trading derivatives?
Asked by
Sam Button categorie-icon time-icon2 months ago
1 Answer Answer Question

Justin Freeman
Answered time-icon2 months ago

Derivatives trading is generally considered to be something for the more experienced trader. It is definitely the case that certain features of Futures and Options are unique to those instruments and need to be fully understood before you actually start trading them. But it is worth approaching the subject with an open mind. Even if you don’t actually go on to trade derivatives, improving your understanding will give an indication of the workings of more advanced strategies.

Looking at how Futures and Options are constructed helps explain how they can be traded.

If you are holding a long position in options you will have the ability, but not the obligation, to convert that position into an underlying instrument. The conversion from option to underlier, technically called the ‘exercise’, will have specified terms and conditions mainly relating to the price at which the conversion occurs and the date it has to happen by.

Futures are contracts obliging the holder to buy or sell an asset at a particular price on a defined date. Originating from the commodity markets Futures were originally designed to offer market participants certainty and allow them to make appropriate business plans to meet their future obligations. They now exist in their own right and allow traders to gain exposure to price changes in a collection of underlying markets ranging from Stock Indices to Natural Gas.

Buying a Put Option on a particular market would effectively be a form of insurance against the price of that market falling. The premium paid to take that option position could be thought of in the same way as an everyday option premium. There is an old adage of a City options trader who each year spent part of his annual bonus on buying to his personal account, Put options on major market indices, with a twelve-month distant expiry date. The thinking be should the markets crash, and his job be put at risk, then the profit on the options would cover some of their downside.

Derivatives are nowadays traded in their own right and seen by some as less of a risk management tool but more as something to speculate on. There are some valuable lessons to take on board before engaging in any such trading.

Advice on options would include, but not be limited to: avoid selling options to other parties. Should you be drawn to the idea of collecting the premium on an option sale then you become the party liable for any change in the value of the underlier.

Futures roll over date is something to look out for. This is more of an operational risk and is covered in detail by the Plus 500 FAQ site. (Link: https://www.plus500.com/FAQ/FinancialInstruments/DoYouOfferRolloverService)

Unless you know with 100% confidence where the markets will be in the near future, make sure you are aware of the risks.

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