Trading securities is one of the many ways young professionals can unlock extra streams of income in addition to their regular 9-to-5 jobs. The advent of online brokers with low minimum requirements, highs-speed Internet, readily-available market news, and mobile-friendly trading platforms makes it easier for ‘outsiders’ to profit from Wall Street. Interestingly, when people think about trading financial securities, most people tend to think about trading stocks.
However, Wall Street is a very long street and there are literarily thousands of ‘shops’ with different kinds of assets; hence, the potential trader is not restricted to trading stocks only. You can trade CFDs, Forex, precious metals, commodities, options, and futures among other things. Derivatives broadly refer to securities derived from other types of assets to provide you with exposures to the underlying assets without actually owning the assets. This piece provides insight into the pros of trading derivatives.
Impressive risk management tool for entrepreneurs
Most people think about derivatives in terms of their speculative use for traders who want to profit from the price changes of underlying assets. Of a truth, most of the traders who buy/sell derivates do not intend to actually take delivery of the physical forms of the underlying asset. However, for the young professional with entrepreneurial leanings, derivates can be an impressive risk management tools for your startup.
For instance, airlines spend as much as one-third of their operating expenses on fuel costs. Hence, CFOs of airline are naturally under pressure to keep track of the costs of jet fuel. However, derivatives could help a proactive airline lock down the price of fuel for purchase/delivery at a future date. Hence, the airline will be in a better position to focus on its core business. If fuel cost rises, the airline won’t have to face an increase in operating expenses. Of course, if fuel costs fall, the airline will lose the money it paid on the contract but such a loss would be offset by the lower fuel costs.
Provides opportunities for different trading strategies
If you trade traditional financial securities such as stocks and ETFs, your opportunities for booking profits will most likely to limited to price gains in the security. Hence, you’ll most likely lose money when the price of the asset fall. More so, you’ll lose money if the price of the security remains stagnant because of the opportunity cost of holding the investment.
However, with derivatives, you can book profits irrespective of the general direction of the underlying asset. With derivatives, you can record profits when the underlying asset is trading up, down, or sideways. In essence, traders of derivative instruments get better opportunity to use different trading strategies to their advantage.
Provides leverage on trading capital
If you have a trading capital of $2000 and you want to trade stocks; ideally, you’ll only be able to buy $2000 worth of stocks. The same is applicable to all other types of securities such as precious metals, forex, and commodities. However, derivatives trading offer an incredible leveraging opportunity that is not readily available to traditional traders or investors.
For instance, some brokers offer as much as 1:10 leverage ratio on trading capital. In the initial instance of $2000 trading capital, if your broker offers a 1:5 leverage, you’ll be able to trade $10,000 worth of the underlying commodity. In essence, a derivatives trader with a $2000 trading capital will technically book the same amount of profit as a traditional trader who invested $10,000 on the trade. However, the biggest downside to leverage trading is that your losses might extend beyond your actual trading capital if the trade goes against you.