What is a Derivatives Tool? Trading Guide and Profit Generation from the Derivatives Market

Derivative tools (derivatives) are not a new concept in the world of finance. Since ancient Mesopotamia, over 2000 years ago, the first futures contracts appeared to meet commercial needs. However, it was not until the 1970s, when modern valuation methods were developed, that the derivatives market exploded and became an indispensable part of today’s global financial system.

What Are Derivatives?

A derivative (derivative) is a financial instrument whose value depends directly on the underlying asset. This asset can be physical commodities such as crude oil, gold, silver, or agricultural products, or financial assets like stocks, bonds, stock indices, or even interest rates.

When the price of the underlying asset changes, the value of the derivative instrument also changes accordingly. This is why pricing derivatives is much more complex than traditional financial instruments, requiring analysts to use advanced mathematical models.

Main Types of Derivatives

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

Forward Contracts (

These are agreements between two parties to buy or sell a certain amount of the underlying asset at a predetermined price, with settlement occurring at a specified future date. Key features include: no intermediary involved, no transaction fees for the parties, but there is a risk of counterparty default.

) Futures Contracts ### Unlike forward contracts, futures are standardized, publicly listed, and traded on official stock exchanges. These contracts are marked-to-market daily based on market prices, require margin deposits at the exchange to ensure settlement ability, and have significantly higher liquidity compared to forward contracts.

( Options ) This is a unique financial instrument that gives the holder the right ###but not the obligation( to buy or sell an underlying asset at a predetermined price within a specific time frame. Since options are assets with intrinsic value, they have their own market price, determined based on the underlying asset’s price.

) Swaps ( These are transactions between two parties involving the exchange of cash flows calculated based on certain principles. Swaps are typically traded over-the-counter )OTC### and are customized contracts between the two parties, not freely tradable like other securities.

How to Trade Derivatives

There are two main ways to access the derivatives market:

Over-the-counter (OTC) market: OTC derivatives are contracts directly executed between two parties without regulatory oversight. The advantage is lower transaction costs due to the absence of third-party involvement. However, risks exist if one party fails to fulfill the contract at maturity.

Regulated exchange market: Derivatives listed on official exchanges undergo strict vetting before trading is permitted. Although transaction fees are higher, participants are protected regarding rights and obligations.

( The Two Most Widely Used Instruments

CFD )Contract for Difference(: CFDs are agreements between two parties )usually investors and brokers( to pay the difference between the opening and closing prices. This is the most popular OTC instrument due to its flexibility and low costs. CFDs have no fixed expiration date, allowing closing positions at any time, and can be applied to thousands of different assets.

Options: Provide traders the right )but not the obligation### to buy or sell an asset at a specified price within a set period. This is the most modern instrument listed on official exchanges, with specific contract durations, but larger trading volumes and higher associated fees.

How to Trade Derivatives

To start trading derivatives, investors need to follow these steps:

Step 1: Choose a trading platform and open an account
Selecting a reputable exchange is the most important factor. A reputable platform helps you avoid risks from counterparties defaulting. The opened account will be your main channel for executing all transactions.

Step 2: Deposit initial margin
The margin amount depends on the volume of assets you wish to trade and the leverage level you choose. Higher leverage allows trading with less capital but increases the risk proportionally.

Step 3: Place trading orders
Based on your market analysis, you will place a Long (predicting price increase) or Short (predicting price decrease) order. This can be done via mobile app or web interface.

Step 4: Manage your positions
After opening a position, you need to monitor continuously, set take-profit orders when profits reach your target, or stop-loss orders to limit losses.

Real-Life Example: Profiting from Gold Price Fluctuations

Suppose the gold price is currently at a peak around ($1683/oz). Based on your analysis, you predict that after economic stabilization, gold prices will drop sharply. Although you do not own physical gold, you can use a gold CFD to capitalize on this price movement.

Implementation: You open a Short position by selling gold at the current price ($1683/oz). When the gold price drops as you forecast and hits $1660, you close the position by buying back, earning a profit of (per ounce.

Leverage effect: If you use 1:30 leverage, you only need $56.1 initial capital to control 1 ounce of gold instead of $1683. When the price drops by $23, your profit will be 41% of your initial capital. Conversely, if the price rises to $1700, you will lose $17, equivalent to 30% of your capital. This demonstrates the power and danger of leverage.

Benefits of Derivatives

Derivatives provide many values to modern financial markets:

Hedging: Originally, derivatives were developed to protect traders from price volatility. Investors can hold an asset that moves inversely to the main asset, so profits from derivatives can offset losses from the underlying asset.

Pricing tools: The spot prices of futures contracts can serve as proxies for actual commodity prices, providing additional market information.

Market efficiency: Through derivatives, it is possible to replicate the cash flows of assets. This promotes the price convergence of the underlying and related derivatives, moving toward equilibrium, and limits opportunities for unreasonable price discrepancies.

Asset access expansion: Through interest rate swaps, companies can achieve more favorable interest rates compared to direct borrowing.

Hidden Risks

Like all financial products, trading derivatives involves significant risks:

High volatility and large losses: Derivatives are extremely unstable. Their complex design makes valuation very difficult or even impossible. Large price swings can cause heavy losses in a short period.

Speculative nature: Due to risks and volatility, derivative prices are unpredictable. Reckless speculative decisions can lead to substantial losses and rapid capital depletion.

Counterparty risk )with OTC contracts$1683 : Contracts traded over-the-counter carry the risk that the other party may default at maturity.

Who Should Trade Derivatives?

Derivatives are suitable for many participant groups:

• Commodity producers: Oil, gold, Bitcoin, or agricultural companies can use futures or swaps to lock in prices and hedge against unexpected price swings.

• Investment funds and trading companies: These organizations use derivatives to leverage, protect portfolios, or enhance asset management efficiency.

• Individual traders and investors: They use derivatives to speculate on various assets, with the ability to leverage to increase potential returns.

Regardless of your group, understanding the nature of derivatives, how they operate, their benefits, and risks will help you make better trading decisions in this market.