Notes with principal protection and high-yield bonds, both of which have lower credit ratings and a higher risk of default but offer higher rates of return, are examples of complex products. To achieve financial goals, complex products may include futures and options, as well as elaborate trading tactics.

Derivatives and leveraged products: an overview

If you begin trading, you will have access to a large selection of financial instruments, including some that are extremely sophisticated. Options and leveraged products are examples of this. These investment products are not appropriate for new investors since they have a higher risk of loss. However, we'd like to provide you a quick overview of them so you can better understand the risks involved.

Derivatives

If you possess stock in a firm, you also own a piece of that corporation. However, other investment items, such as stocks and commodities, derive their value from an underlying asset or product. Derivatives is a good name for these items. Derivatives can be used by experienced traders to speculate on market movements or to hedge risk. Although derivatives can yield a large return in some situations, they are often associated with significant expenses and risk.

Options

An option contract is a common example of a derivative. If you believe that the price of a stock will change in a certain way, you can use an option to trade on that opinion. Options, as the name implies, allow you the right to buy or sell an underlying asset, such as a stock, at a preset price at a future date. A call option allows you to buy the underlying product, whereas a put option allows you to sell it.

Let's say the price of a stock is £20 right now, but you predict it will rise in the next month. You can then purchase one call option, which gives you the right to purchase this stock at a predetermined price at a later date. Let's say you choose an option that allows you to acquire 100 equities for £21 apiece in two months. You must pay a fee, such as £1,50, to gain this right. This premium must be multiplied by a factor, which is usually 100 and represents the number of stocks covered by the option. As a result, if you buy this option contract, your total investment will be £150.

You can execute the option and start a position for 100 stocks at a price of £21 per stock if the stock price increases to £25 at the end of the two months. You may make a straight profit by selling the stocks because the market rate is greater. You would then receive 25 Euros each share from the sale. Taking into consideration the £21 purchase price and £1.50 premium, the profit is £2.50 each stock, or £250 total. You would have gotten returns across 7 shares instead of 100 if you had utilized the initial investment of £150 to buy the shares directly, and you would have benefited less from the increase.

Future contracts are another common sort of derivative. Futures are standardized contracts that are made between two parties at a defined price and expiration date, similar to options. Unlike options, nearly all futures contracts are settled by cash payments rather than the physical delivery of the underlying goods at the end of the term. In addition, when compared to options, the contract size tends to be larger.

Assume you believe a stock index will rise. It's currently worth £600, and you're thinking of buying a futures contract with a £200 multiplier. This futures contract's total value would be £120.000. When trading futures, you don't have to buy the entire contract; instead, you often put down an initial margin. Let's say there's a 15% margin rate. By depositing at least £18.000 as margin to your account, you would obtain a £120.000 exposure to the underlying. With a futures contract, you can gain a high exposure for a modest initial margin.