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Investing in Derivatives

There are So Many Derivative Based Investments

The first thing that comes to mind for most people when they think about investing in derivatives are stock options, but in reality, derivative investing entails so much more than that!  To understand how you can use derivatives as part of your investing strategy (which you probably already do), it is best to start by understanding what derivatives are, and then take a closer look at the types of derivatives that are available for investment.

The definition of investment derivatives is quite simply investing in something other than a specific asset.  It is typically done through some type of contract that is based on the value of an underlying asset.  For example, you can invest in gold without actually owning the gold.  Or, you can invest in a big bundle of stocks by buying an index fund that doesn't actually own the underlying stocks.  Derivative values are derived by underlying assets and the changes in their price.  Below is a list of some of the more common derivative investments.

Mutual Funds.  Many mutual funds use derivatives as part of their investments.  Sometimes they are used for diversification or to increase or reduce risk.  Most leveraged funds use derivatives.  Mutual funds can be bought or sold through any investment company, brokerage and most retirement plans.

Index Funds.  Index funds, including most ETFs, don't actually own the underlying stocks, but instead own derivatives that are designed to track the value of the underlying assets.  Index funds and ETFs are available through almost any broker and also through many retirement plans.

Stock Options.  Stock options are by definition a derivative since they are a contract to buy or sell an underlying stock and the value of the option is based on the underlying stock and its moves.   Stock options can be purchased through any brokerage, but you must have a margin account to do so.

Financial Spread Betting.  Financial spread betting is a form of investment that allows you to bet on whether or not an underlying asset, index or currency will go up or down.  For example, if you think the price of the Pound is going to increase versus the value of another currency, you can bet on it with spread betting.  Spread betting has become popular in the UK and can be done through online trading partners like ETX.

CFD Trading.  Contract For Differences are another form of derivative that can be used to speculate or hedge.  For example, you could enter into a CFD that would pay you the difference between a set price and the actual price at the end of the contract.  If you think the underlying asset is going to move dramatically, you could use this type of contract to receive the set price at the end of the contract.  CFDs are popular in specific parts of the World but not available for investment in the US.

Life Insurance.  Some life insurance policies are derivatives, since you are purchasing a contract that changes in value based on an underlying event.  Insurance must be purchased through representatives that are registered to transact business in your locality.