A derivative is a security whose price is dependent upon or derived from one or more underlying assets. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. Derivatives pay off over a period of time based on asset performance, interest rates, exchange rates or indices.

Forms of derivatives

Futures: A future contract is an agreement between two parties to buy or sell an underlying asset at a certain time in the future at a certain price. The price of future price is usually higher than the prevailing market price of the security.

Options: Options are also derivatives that give the buyer the right to buy or sell the underlying asset on or before at a stated date and at a started price. But unlike futures, the investor is under no obligation to buy or sell the underlying at a stated date and at a stated price.

Investment in derivatives uphold the following benefits:

  • Hedge against risk
  • Flexibility & lower cost
  • Generate  higher returns

What makes derivatives investing an indispensable part of a portfolio?

  • Provide risk protection with minimum investment and capital consumption
  • Give investors choice to trade on future price expectations
  • Low total transaction costs compared to investing directly in the underlying asset
  • Give fast product innovation because new contracts can be introduced rapidly
  • Can be tailored to the specific needs of any user