What are derivatives and how are they used in investment strategies?

What are derivatives and how are they used in investment strategies?

Derivatives are financial contracts whose value is derived from an underlying asset. They are used in investment strategies for hedging, speculation, and increasing leverage.

Can you give me an example of how derivatives can hedge against risk?

Sure! For instance, a farmer can use futures contracts to lock in a price for their crops, protecting against price drops at harvest time.

What are the risks associated with using derivatives?

The main risks include market risk, credit risk, and liquidity risk. Derivatives can amplify losses if the market moves against your position.

How do options differ from futures in derivatives?

Options give the buyer the right, but not the obligation, to buy or sell an asset at a predetermined price, while futures require the buyer to purchase the asset at the contract's expiration.

Are there any specific strategies that utilize derivatives?

Yes, common strategies include covered calls, protective puts, and straddles, each serving different investment goals.