Derivate Investments
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Equities are probably the most commonly traded investment instrument but they do suffer one particular problem. If you are holding shares or purchasing shares, you can not benefit (or will find it very hard to do so) from short term volatility. Similarly, if you are certain a share is going to fall, whilst you can wait till it does and then buy in, you can not benefit from this actual fall. This is called “shorting” a stock and only the major investment banks are capable of doing these kind of activities and for a while it was actually made illegal by the government as it was driving share prices down during the recession.
However, there are certain financial instruments based upon equities, such as options and futures, which do make it possible to benefit from falling share prices. These options and futures are called derivatives (as they are usually derived from underlying equity or other security) and also include other financial instruments such as warrants, contracts for difference and even spread betting. The list is virtually endless with many different instruments falling under the bracket of derivatives and as the likes of the investment banks can construct new derivatives almost at will to fill a particular gap in the market.
Such derivatives can usually be purchased for a fraction of the cost of a position in the underlying equity itself, that is, they are highly geared. They are therefore liable to be much more volatile than the underlying equity upon which they are based, with a correspondingly higher potential loss but also a much higher and much quicker potential gain. Spread betting on any of the various currencies, equities, commodities or indices can give large potential gains or losses in the space of minutes and even seconds. Used alone, derivatives perhaps have more in common with gambling than investment. However, in combination with a portfolio of the underlying shares upon which they are based, derivatives can be used to reduce risk.
Although private investors are well advised to leave derivatives alone unless they themselves have a particular expertise, professional investors are well used to dealing with such financial instruments. A private client portfolio, investing directly in equities, and managed by a firm of stockbrokers or similar, is unlikely to include derivatives but a professional fund manager running a unit trust or OEIC (Open Ended Investment Company) may well use them to some extent.
However, most managers of most retail collective funds will not use derivative instruments to a great extent, often as a result of regulatory restrictions. Whether their fund grows under their management will be largely a function of the capital appreciation secured by the individual investments they hold within their fund. A private investor looking to profit from shares when prices are falling must go elsewhere.
However, there are certain financial instruments based upon equities, such as options and futures, which do make it possible to benefit from falling share prices. These options and futures are called derivatives (as they are usually derived from underlying equity or other security) and also include other financial instruments such as warrants, contracts for difference and even spread betting. The list is virtually endless with many different instruments falling under the bracket of derivatives and as the likes of the investment banks can construct new derivatives almost at will to fill a particular gap in the market.
Such derivatives can usually be purchased for a fraction of the cost of a position in the underlying equity itself, that is, they are highly geared. They are therefore liable to be much more volatile than the underlying equity upon which they are based, with a correspondingly higher potential loss but also a much higher and much quicker potential gain. Spread betting on any of the various currencies, equities, commodities or indices can give large potential gains or losses in the space of minutes and even seconds. Used alone, derivatives perhaps have more in common with gambling than investment. However, in combination with a portfolio of the underlying shares upon which they are based, derivatives can be used to reduce risk.
Although private investors are well advised to leave derivatives alone unless they themselves have a particular expertise, professional investors are well used to dealing with such financial instruments. A private client portfolio, investing directly in equities, and managed by a firm of stockbrokers or similar, is unlikely to include derivatives but a professional fund manager running a unit trust or OEIC (Open Ended Investment Company) may well use them to some extent.
However, most managers of most retail collective funds will not use derivative instruments to a great extent, often as a result of regulatory restrictions. Whether their fund grows under their management will be largely a function of the capital appreciation secured by the individual investments they hold within their fund. A private investor looking to profit from shares when prices are falling must go elsewhere.
