Trading for Dummies® 2nd Edition

Chapter 18. Doing It by Derivatives

In This Chapter

• Defining derivatives

• Opting for options

• Figuring on futures

• Considering commodities

• Exploring the risks

Traders can raise the bar on the leverage they're allowed by opening the door to the derivatives markets. Derivatives are any financial instruments that get or derive their value from another financial security, which is called an underlier. This underlier is usually stocks, bonds, foreign currency, or commodities. The derivative buyer or seller doesn't have to own the underlying security to trade these instruments.

You may unwittingly encounter derivatives if you trade those exchange-traded funds (ETFs) that offer to return two or even three times the value of an underlying stock index. Those ETFs use derivatives to amplify the reward — and the risk. And you may recall that derivative trading, especially those derivatives tied to the value of underlying mortgage assets, exacerbated the mortgage mess that started the financial collapse of 2008.

Warning

Derivatives traders use futures and options, which are the two most common types of derivatives, to make money in a highly risky venture. In this chapter, we introduce you to a variety of derivatives, how they're traded, and the risks involved in trading futures and options. However, you need to seek additional training before jumping into this kind of trading.

Types of Derivatives: Futures and Options

Derivatives are marketable instruments, which over time acquire and relinquish value based ...