Derivatives turnover has increased by huge amounts in Australia in recent years. A 2004 a BIS survey suggested a rise of 47 percent compared to the previous survey, with this expansion in the Australian derivatives market largely due to an appreciating Australian dollar. Getting started on the stock market is sometimes no mean feat. If you’ve ever wondered what derivatives are, or how derivatives work, you’ve come to the right place.
What are derivatives?
In short, derivatives can be defined as financial instruments or financial arrangements, which essentially derive their value from, or whose prices are based upon, some underlying stock, bond, commodity or other various other assets. Futures, swaps, options and warrants, as well as certain mortgage-backed securities are the most common derivative forms. Where Australian exchanges are concerned, there are a wide variety of derivative products available to trade, including, most commonly, futures, options and warrants. Derivatives are usually used to hedge or transfer risk but are also used for speculative purposes by some investors.
How do derivatives work?
As with basic share trading, you are betting that the value derived from the specific underlying asset in question will either increase or decrease by a certain amount, within a certain period of time.
Two common types of derivatives on the Australian market are futures and options. With an options contract, the purchaser or buyer pays a fee (the premium) to the “grantor” for the right, but not the obligation (this is the crucial part) to buy or sell the asset to the grantor at a set price before a certain date. Where a futures contract is concerned, the owner is obliged to buy or sell the asset in question. This comes with a warning from many experts; options sellers often lose out. For more information, the Australian Stock Exchange is a good place to look.
Aren’t derivatives just like stocks or bonds?
Many people compare derivatives to stocks or bonds but a derivative is usually a contract, as opposed to an asset. So basically, instead of buying the asset, you are buying a promise to take ownership of the asset. What many investors value where derivatives are concerned is the flexibility: the legal terms are more flexible than the terms of property ownership, and many experts will tell you derivatives can provide a “fuller range” to your investment strategy.
