Definition: A financial contract whose value derives from the value of underlying stocks, bonds, currencies, commodities, etc.
Derivatives are generally used to either hedge or to gain leverage to trade a movement in an underlying instrument.
The Sydney Futures Exchange (SFE) began trading as the Sydney Greasy Wool Futures Exchange (SGWFE) in 1960. Its goal was to provide Australian wool traders with hedging facilities in their own country. So Wool Futures were the first listed derivatives in Australia. https://www.asx.com.au/about/history.htm
Since then the market has grown significantly and there is a vast amount of different types of derivatives that can be used for Hedging and Trading. Most major markets around the world have a range of derivatives listed.
The most common derivatives on the ASX are Exchange Traded Options, Warrants, and Futures.
Exchange Traded Options (ETO):
An ETO is a contract that gives you the right but not the obligation to buy or sell a given security at a certain price within a given time. The Price of an option is made up of the underlying share price, expected volatility, time to expiry and the risk-free rate.
Options are one of the most flexible financial products, in that there is various strategy’s that can be used to trade the market up, down or sideways. If you have a portfolio there are various strategies that can be used to either hedge or generate income in a sideways market.
The ASX options market has been operating since 1976. There are now over 60 different companies and the S&P ASX 200 share price index to choose from.
There are various types of warrants that can be used for Investing and Trading. Each of the different types of Warrants has their own characteristics, risk profiles, leverage and terms.
Warrants will generally have a Bank providing the product which is then listed and traded through the ASX.
Our trading warrant of choice is Mini Warrants which are provided by CitiFirst, basically, a Mini gives you leverage which means you don’t have to put up as much capital as buying shares. A Mini long is used to trade a bullish view and a Mini Short used to trade a bearish view. Warrants are popular as the risk is limited to the original capital in the trade and there is no Margin.
Future Contracts are an agreement between two parties to buy or sell something at a certain price, at a specified time in the future. The asset transacted is usually a commodity or financial instrument.
In general, futures are heavily leveraged and have a margin element which means you can lose more than your initial capital outlay, and the margin will fluctuate depending on how the trade is performing. Futures are used more by Market Makers, Banks and Traders.
Derivatives give you the ability to make larger profits from smaller movements in share price vs buying the stock directly. But it also increases losses, so you need to learn the risks of the product you choose and ensure you have a system to follow to keep risk under control. Another way to look at it is that you can put a smaller amount of money on a derivative to get a similar result as putting a large amount of money on stock.
We use a combination of ETOs and Mini Warrants as a strategy that complements each other. Options provide access to strategies both in the reporting season and when the market goes sideways. Whereas, Minis are a great way to trade a directional view having an embedded stop loss feature.
Using a combination of Options and Mini Warrants gives access to over 200 shares, indices locally and offshore, and a selection of commodities, all traded through the ASX. This is important to have peace of mind that your trading bank is safe, and the other side of your trade is guaranteed once filled.
If you are looking to learn to trade, you need:
- A set of rules to help you enter and exit the market whilst controlling your risk and keeping your own psychology out of the way.
- Choose which market you want to focus on.
- What instrument/s you will use.
- An advisor to run your ideas past and help you with transacting.
- A Broker, either Full Service or Online that you trust.
We provide both Education services and Broking services to clients of all levels whether beginner or experienced. If you would like to learn more, call us on 03 80805788 or fill out the form at the bottom of the page.
Our next course is a One day Mini Course scheduled for Sunday 7th October.