Investing in Derivatives
Investing in derivatives allows investors like you to speculate on asset prices without actually owning them. This type of investing takes the ability to predict prices and great timing, and buying the most common derivatives (futures and options) will let you make a small investment with a high potential for profit. Those that sell derivatives should protect their investment by asking high premium payments and by hedging their bets. There are multiple pricing models, which allow one to get an idea of how much derivatives contracts are worth.
When you invest in stocks, you often have to commit a significant amount of money for a sizable period of time before you realize a return. Investing in derivatives is an alternative, where you can guess how the market for a particular security will work, all at a fraction of the true purchase price of the security. This market offers greater flexibility, but it is very volatile. You should take steps to protect yourself from suffering losses.
The safest method of investing in derivatives is to buy the contracts. Being the buyer puts you in the long position, which means that your only risk is the premium you pay. If the contract declines in value, you only lose the premium, but if it increases in value, you can realize huge profits. The seller, being in the short position, should raise the premium to offset potential losses, or hedge against them by taking the opposite position on the underlying asset.
As futures or options are dependent on market movements, it's hard to determine the contracts' value at purchase time. For this very reason, options and pricing models can help determine the true worth of a contract. Some models can predict underlying asset prices for the entire duration of the contract, which can help you decide when to sell.