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How Investors Perceive Derivative Trading?

Despite of its benefits, derivative trading has acquired a bad image to investors due to fundamental factors such as negative news, inaccurate opinions, misinformed perceptions and insufficient comprehension. Several people base their opinions only on the negative stories they see on television or read in newspapers. This led many investors to neglect the possible rewards derivatives can offer.

 

The growth of derivative trading is remarkable even with the negative publicities. Investors, who understand it, know how it can assist them in spotting the price changes of the underlying assets. Derivative contracts usually offer significant leverage as well as low cash requirement that enable the speculator to create high profits resulted from minimum actions in the value of the underlying security. Investors use them as security or protection from adverse price alteration. Traditionally, investors use most derivatives to minimize risk of future price change.

 

There are four common opinions investors usually have on derivative trading:

 

  • Several investors find this type of trade complicated. This is true for some derivatives especially that investors may need to review the list of equity options or covered writings. In addition, investors need to familiarize themselves with puts, calls, calendar spreads, strips, straps, strangles, bull spreads, butterfly spreads, bear spreads and straddles.
  • Investors find this type of trade expensive. Although the products have become commoditized, the services have not. This service requires a lot of work and it is just logical for it to require a fee. The damage of losing a huge part of market value due to lack of security on your portfolio can end up becoming more expensive.
  • Investors perceive it as an institutional market. This is true according to the research performed by a consulting company known as Greenwich Associates. It states that in 2005, the national volume of interest rate derivatives was close to $1.5 trillion, 85% of which belongs to the 260 institutions that each traded a value of more than a million dollars. Derivatives, is an international marketplace in which 63% came from the U.K. and Europe, 27% in Canada and the United States, and 10% is in the Pacific Rim and Asia.
  • Investors see it as entirely speculative and hugely leveraged. Hedge vehicles become very risky when utilized as a main investment. Several investors fail to see that derivatives can alleviate risk once used the right way. Some investors make the mistake of ignoring single stock ownership risk, systematic risk, credit risk or event risk. They also fail to comprehend that some derivatives are contract markets.

 

Many experienced traders know that derivative trading is less risky compared to other type of trades. The growth of risks can only rapidly increase once a hedge vehicle is utilized as an investment. However, success in this trade will depend on how suitable an investor is in a certain market.

 

CL King is a full-service investment bank and provides equity research, sales and trading, and investor services to corporations and institutions. The firm offers investment research, equity and fixed income sales and trading, prime brokerage, investment advisory, and clearing services. To align with CL King experts' capabilities call at 518.447.8050

 

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