Derivative Tools in Financial Trading: Principles of Operation, Types, and Business Opportunities

What Are Derivative Instruments? Basic Concepts

Derivative Securities (derivative) are a type of financial contract whose value is determined by the price of one or more underlying assets. The unique point of this instrument is that it is not a physical asset but rather an agreement that records the price fluctuations of the underlying asset.

Underlying assets can include:

• Commodities: crude oil, gold, silver, agricultural products
• Financial assets: stocks, bonds
• Market indices: stock indices, interest rates, currencies

Unlike traditional financial instruments, the valuation of derivatives is significantly more complex because it depends on many constantly changing factors from the underlying assets.

The history of derivative securities is not as modern as many think. The emergence of the first futures contracts can be traced back to the second millennium BC in Mesopotamia. However, widespread applications in modern finance only began in the 1970s when new mathematical valuation methods were developed, fueling the explosive growth of this market.

Main Types of Derivative Instruments

The modern derivatives market consists of four main contract groups, each with its own mechanism and characteristics.

Forward Contract (

This is an agreement between two parties to buy or sell a certain amount of an asset at a predetermined price on a future date. Key features:

• Payments occur according to the agreed schedule
• No intermediary organization involved
• No brokerage fees for the parties
• Asset prices fluctuate daily based on market value

) Futures Contract ###

Futures are a standardized version of forward contracts, officially listed and traded on stock exchanges. Main differences:

• Significantly higher liquidity compared to forwards
• Both parties must post margin at the exchange to ensure settlement
• Contract value is updated and determined daily based on market prices

( Options )

This instrument grants the holder the right ###not the obligation( to buy or sell an asset at a predetermined price within or at a specific time. Features:

• The only financial instrument that provides a choice, not an obligation
• Options have their own market-determined value
• Option prices are calculated based on the underlying price and complex valuation formulas

) Swaps (

These are transactions between two parties to exchange different cash flows, calculated based on pre-defined principles. Characteristics:

• Usually traded over-the-counter (OTC) )OTC###
• Cannot be bought or sold like other securities
• Independent contracts between two separate parties

Two Trading Channels for Derivative Instruments

( Over-the-counter (OTC) Trading )

OTC derivatives are contracts made privately between two parties and are not tightly regulated. Advantages:

• Lower transaction costs due to absence of third-party involvement
• High flexibility in contract design

However, potential risks:

• High risk of one party defaulting at settlement
• Lack of oversight by regulatory authorities

( Exchange-Traded and State-Regulated Trading )

Derivatives listed on these exchanges must undergo thorough vetting before being allowed to list. Benefits:

• Ensures rights and obligations of participants
• The exchange acts as an intermediary to protect both sides

Disadvantages:

• Higher transaction fees
• Less flexible compared to OTC

Most Widely Used Derivative Instruments

CFD (Contract for Difference)

CFD is an agreement between an investor and a broker to pay the difference in the price of an asset between the opening and closing of a position. It is the most popular OTC instrument because:

• Contracts have no expiration date and can be closed at any time
• Applicable to over 3,000 types of commodities
• Low transaction costs
• Allows high leverage, significantly reducing initial capital requirements
• CFD prices closely track the underlying asset’s price

Options ###Option(

Provides the right )but not the obligation### to buy or sell an asset at a specific price within a defined period. Features:

• Considered the most modern instrument among listed derivatives
• Only assets with specified contracts have options
• Large trading volume but with higher transaction fees
• Option prices require complex valuation formulas

Comparison of CFD and Options:

Unlike CFD prices which always match the underlying asset’s price, a one-point movement in the underlying asset is never equal to a one-point change in the option contract. This makes options more complex in risk management.

Derivative Trading Process

To start trading derivatives, investors should follow these steps:

Step 1: Choose a Trading Platform and Open an Account

Selecting a reputable trading platform is crucial. A trustworthy platform helps you avoid risks from the counterparty defaulting. Research the platform’s supervision, licensing, and reputation within the trading community.

Step 2: Deposit Margin/Initial Capital

The amount depends on:

• The type and quantity of assets you plan to trade
• The leverage level you choose to use

Step 3: Execute Buy/Sell Orders

After depositing sufficient margin, you can place trading orders. Based on your market forecast, you may:

• Open a Long position (mua) if you expect prices to rise
• Open a Short position (bán) if you expect prices to fall

Orders can be placed via mobile apps or web interfaces.

Step 4: Manage Positions - Take Profit and Stop Loss

Continuously monitor your positions and decide when to close them to secure profits or limit losses.

Practical Example: Gold CFD Trading

Let’s consider a specific scenario to understand how to profit from derivatives:

Context: Gold is currently at a record high of $1,683/oz. Based on personal analysis, you forecast a sharp decline as the economic situation stabilizes. You decide to trade gold CFD without owning physical gold.

Step 1: Open a Short Position

Since you expect prices to fall, you open a Short (bán) position at the current price of $1,683/oz. When gold prices decline as predicted, you close the position by buying back at a lower price, earning the difference.

Step 2: Use Leverage

With gold at $1,683/oz, the required capital is large. You choose to use 30:1 leverage, reducing the initial capital from $1,683 to just $56.1 to control 1 oz of gold.

Comparison Results:

If the gold price drops to $1,660 and you close the position:

• With 30:1 leverage: Profit (= 41% of initial capital
• Without leverage: Profit )= 1.36%

Conversely, if your forecast is wrong and the price rises to $1,700:

• With 30:1 leverage: Loss (= 30% of capital
• Without leverage: Loss )= 1%

This example clearly illustrates how leverage amplifies both profits and losses.

Benefits of Derivative Trading

Derivatives have become an indispensable part of the global financial system for the main reasons:

**Hedging $23 Hedging$23 **

The primary function of derivatives is to protect parties from undesirable price fluctuations. An investor can buy a derivative that moves inversely to the asset they own, offsetting potential losses.

Underlying Asset Pricing

The spot price from futures contracts can serve as a close indicator of the actual commodity’s price, helping market participants assess fair valuation more clearly.

Market Efficiency Enhancement

Using derivatives allows traders to replicate cash flows similar to the underlying assets. This creates pressure to keep the prices of underlying assets and related derivatives in balance, preventing large arbitrage opportunities.

Access to Favorable Interest Rates

Through interest rate swaps, companies can secure better interest rates than direct borrowing in the market.

Risks Associated with Derivative Trading

Despite many benefits, derivatives trading also involves significant risks:

Extreme Price Volatility

Derivatives can experience very large price swings, leading to losses exceeding expectations. The complex design of contracts makes accurate valuation extremely difficult or even impossible, making high risk an inherent feature.

Speculative Risks

Due to the high risk and volatility, derivative prices are unpredictable. Unprepared speculation can lead to heavy losses.

OTC Trading Risks

OTC contracts are not fully regulated by state authorities. If the counterparty defaults at settlement, you may face major difficulties in dispute resolution.

Control Risks

Contracts that do not meet standard vetting are traded on decentralized platforms with weaker investor protections.

Who Are the Participants in Derivative Markets?

Various groups use derivatives for different purposes:

Commodity Producers

Oil producers, gold miners, or agricultural farms can benefit from futures or swaps. They use these tools to lock in prices for their products, reducing the impact of market price fluctuations.

Hedging Funds and Portfolio Management Companies

Financial organizations use derivatives as comprehensive risk management tools or to leverage their portfolios for increased efficiency.

Traders and Individual Investors

Experienced market participants use derivatives to speculate on price movements of various assets. They can leverage to amplify profits from accurate market forecasts.

Mastering derivatives is a fundamental step for anyone wanting to participate in modern financial markets.