Why Buy Derivatives?

There are two main reasons to buy derivatives: speculation and hedging. Certain securities, such as CFDs, provide investors with a way to trade assets without actually holding them. For example, if you want to invest in crude oil, you can choose to trade the price of crude oil without having to vacate your garage to store it.

Many institutional investors include a variety of financial derivatives in their portfolios. However, these derivatives are not its core portfolio. The core portfolio is usually a safer asset, such as government bonds, as a lower-yielding but safe annual income.

In contrast, derivative contracts are often referred to as "satellite shares", where investors "gamble" to get a more generous or higher interest rate return on their investment, which is speculation.

Investment derivatives can be used to offset risky investments already in the portfolio, a practice known as hedging. For example, if the portfolio contains corporate bonds, credit default swaps can be used as a guarantee against bond default.

There are many more examples of hedging, but let's get back to business and dive into some of the different types of derivatives. First, let's look at some of the more common investment products that are easier to understand and trade.