## What You Need to Know About Derivatives Trading

**Derivative financial instruments** have long been an essential part of the global financial markets. Although their origins can be traced back to ancient civilizations, their true development began in the 1970s with the advent of modern valuation methods. Today, no advanced financial system can operate effectively without these tools.

## What Are Derivatives? Basic Definitions

**Derivative securities** are financial contracts whose value is derived from the price of an underlying asset. The underlying asset can be:

- **Physical commodities**: oil, gold, silver, agricultural products
- **Financial assets**: stocks, bonds, stock indices
- **Other economic factors**: interest rates, currencies

When the price of the underlying asset fluctuates, the value of the derivative also changes accordingly. This makes pricing more complex compared to regular financial instruments.

## Common Types of Derivative Securities

The derivatives market includes many different types of contracts, each with its own characteristics:

**Forward Contract (Forward)**
- An agreement between two parties to buy or sell an asset at a future date at a price set today
- No third-party intervention
- High settlement risk due to lack of an intermediary guarantee

**Futures Contract (Future)**
- Standardized version of a forward contract
- Traded on regulated exchanges
- More liquid
- Parties must deposit margin at the exchange
- Prices are marked-to-market daily based on market prices

**Option Contract (Option)**
- Grants (the right but not the obligation) to buy or sell an asset at a specified price within a certain period
- The right has its own value
- Valued based on the underlying market
- Officially listed on exchanges
- Modern and highly regulated derivative tool

**Swap Contract (Swap)**
- A transaction between two parties to exchange cash flows
- Cash flows are calculated according to specific rules
- Often traded over-the-counter (OTC)
- Terms are customized to participant needs

## How to Trade Derivatives

There are two main channels for participating in derivatives trading:

**Over-the-Counter (OTC) Market (Over-the-Counter)**
- Contracts are directly negotiated between two parties
- Lower costs due to absence of intermediaries
- Risks include one party defaulting at settlement
- Not officially regulated

**Regulated Exchange Markets**
- Contracts must be pre-approved before listing
- Higher transaction fees
- Rights and obligations are protected
- Greater transparency

The two most widely used derivatives tools are:

**CFD (Contract for Difference)**
- Settlement based on the difference in price between opening and closing positions
- Mainly traded OTC
- Contract between trader and broker
- Can apply high leverage
- No expiration date; positions can be closed at any time
- Applicable to over 3000 assets
- Low trading costs

**Options**
- Provide the right to buy or sell an asset at a specific price within a set timeframe
- Officially listed on exchanges
- Require complex valuation calculations
- Have expiration dates; can only be closed before or on the expiry date
- Higher trading fees than CFDs
- Not all assets have options

## Step-by-Step Derivatives Trading Process

**Step 1: Choose a Trading Platform**
Selecting a reputable and secure exchange is the most important factor. A trusted platform helps minimize the risk of counterparty default.

**Step 2: Open an Account and Deposit Initial Capital**
Traders need to open a trading account and deposit margin. The required amount depends on the asset type and leverage used.

**Step 3: Execute Trades**
With sufficient capital, traders place orders based on their market forecasts. Orders can be Long (predicting rise) or Short (predicting fall).

**Step 4: Manage Positions**
Monitor open positions, take profits when profitable, or cut losses to control risk.

## Real-Life Example of Derivatives Trading

Consider a scenario: Gold is currently priced at $1,683 per ounce. A trader predicts that after economic stabilization, gold prices will drop significantly. Even without owning physical gold, the trader can participate in the derivatives market based on this price movement.

**Short Strategy with 1:30 Leverage**

| Scenario | Initial Capital | Absolute Profit/Loss | Profit/Loss % |
|---------|------------|---------------------|--------------|
| Price drops to $1,660 | $56.10 | +$23 | +41% |
| Price rises to $1,700 | $56.10 | -$17 | -30% |

**Comparison Without Leverage**

| Scenario | Initial Capital | Absolute Profit/Loss | Profit/Loss % |
|---------|------------|---------------------|--------------|
| Price drops to $1,660 | $1,683 | +$23 | +1.36% |
| Price rises to $1,700 | $1,683 | -$17 | -1% |

This example illustrates how leverage can amplify both gains and losses. Using 1:30 leverage allows trading with a smaller capital but also involves higher risk.

## Benefits of Derivatives Trading

Derivatives markets offer many significant advantages for the financial system:

**Risk Hedging**
Investors can buy derivatives that move inversely to their owned assets, offsetting potential losses.

**Fair Price Discovery**
The spot price (spot) of futures contracts can more accurately reflect the true market value of commodities.

**Market Efficiency**
The ability to replicate asset cash flows through derivatives helps maintain price balance and prevents arbitrage opportunities.

**Access to Assets**
Interest rate swaps enable companies to achieve better borrowing rates than direct loans.

## Risks to Be Aware Of

All financial instruments carry inherent risks:

**High Price Volatility**
Derivatives are highly volatile, and their complex structures make valuation difficult, leading to potential significant losses.

**Speculative Nature**
Since prices are unpredictable, irrational speculation can cause substantial losses.

**Settlement Risks**
OTC contracts carry the risk of counterparty default at settlement. Exchange-traded contracts have lower such risks.

**Valuation and Listing Requirements**
Not all contracts are officially listed; non-standard contracts are traded OTC with higher risks.

## Who Should Trade Derivatives?

Derivatives serve various purposes for different groups:

**Exploiting Companies**
Oil, mineral, or cryptocurrency mining companies can use futures to lock in prices and hedge against volatility.

**Investment Funds and Trading Firms**
They utilize derivatives for leverage, risk management, or enhancing asset management.

**Individual Traders**
Retail investors use derivatives for speculation and increasing profits through leverage.

Derivatives trading requires deep knowledge, strong risk management skills, and a clear understanding of the markets. Success depends not only on strategy but also on discipline and smart capital management.