Derivatives: Deadliest Weapon in the world for those who play it wrong!

Derivatives are risk management instruments being traded in the stock exchanges. They are the major volume drivers of the total trade that takes place in an exchange. Usually, the trade in derivatives contribute to nearly 70% of total volumes of the exchange.

Derivatives: As the name suggests, they are those instruments whose value is derived by some other underlying asset which can be equity share, benchmark (index), bond etc.

Derivatives have been claimed to be “Financial instruments of mass destruction” by famous investor Warren Buffet.

They have a tendency of being highly volatile. But, at the same time an immensely used financial instrument to hedge financial risks. They are excellent hedging tools but, I doubt if it is also an excellent trading tool. May be yes, if you manage to be on the right direction, at the right time and for the right duration, because there are numerous factors which effect the pricing and volatility of different types of derivative instruments.

They also bring some stances when there is a good possibility of low risk and high gain trades. E.g: Shorting options on Deep OTM.

Derivatives have certain instruments and positions where the trader has unlimited risk. So, it is essential to maintain strict stop losses in those cases.

Usually traders come for Derivative trading especially options trading by seeing profits of 2X-10X. But, it is essential to have a prior deep understanding of markets and the instruments in order to start trading in them. So, trade carefully if you want to. Else, leave it for the professionals to use it for hedging purposes (the reason it is meant for! ).

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