A derivative is a financial product that enables traders to speculate on the price movement of assets without purchasing the assets themselves. Because there is nothing physical being traded when derivative positions are opened, they usually exist as a contract between two parties.
Most derivatives involve margin trading, and offer a larger amount of flexibility when it comes to using different trading strategies across a variety of asset classes. They allow the opportunity to trade on volatility itself, instead of relying on positive moves in an asset’s price.
Derivative products come in a variety of forms, with huge differences between them. Some of the major derivatives used by traders are:
- Spread betting: enables you to place a bet on the movement of a market, with the level of profit or loss defined by the amount the market moves before the position is closed
- CFDs (or contracts for difference): an agreement between two parties to pay the difference in price of an asset between the time a position is opened and when it is closed
- Options*: give traders the right – but not the obligation – to purchase or sell an asset at a certain price within a certain timeframe