What are derivatives?

If you want to learn more about the financial market, you will need to find out about what are derivatives.

They are an important part when we talk about financial instruments and the asset market.

What are derivatives?

Derivatives are very important in the financial market, they are a type of financial instrument that has a value derived from the price of an underlying asset, which can be a stock, a commodity, a foreign currency or an index.

They can also be fixed, such as soybeans, coffee, or financial ones, as we have already mentioned, which can be shares or currencies.

How do they work?

Derivatives are typically traded on the B3, on the stock exchange and are basically standardized contracts with two parties involved.

These parties involved have a purchase and sale obligation with a stipulated date and value, as agreed.

When making a derivatives contract, everything must be defined, such as deadlines, what the assets are, quotation method, quantity of assets and others.

We can think of derivatives as a contract between two parties, but they also serve as protection against the risks of fluctuating values and speculation on the future movements of assets.

Thinking about a more practical example, let's think about a physical asset for this. For example, a farmer starts working on his crop that will bear fruit in 60 days and at the first moment he is already spending on the necessary resources.

And at the same time that he begins his harvest, which for example, is coffee, the market value per kg is costing R$$50 reais, but until then this value can fluctuate and be even lower.

So, for this, a futures contract can be made that has a harvest term of 60 days, so with this contract the farmer guarantees that even if the market value falls, he will still receive R$$50 reais for his harvest.

In this case we can understand that the price was derived from coffee, but in real situations, the value derives from foreign currencies, financial indexes and others.

Different types of derivatives

And when talking about derivatives, we cannot fail to mention the different types that exist in the financial market.

These are the forward market, swaps, the futures market and also the options market, but now, let's learn more about each of them.

Forward market

Called the forward market, this is one of the simplest contracts available.

Its process is also very simple, in which the investor commits to purchasing a specific financial asset at a specific price on a pre-established date.

Both parties are obliged to fulfill the contract, that is, the purchase or sale of the asset will occur on the expiration date, regardless of the price variations of the underlying asset during the period.

They are always traded on the stock exchange, but with certain specifications that already come in standards.

Swaps

A less common modality is swaps, in which both parties to the contract agree to exchange cash flow or future payments, which is why this transaction is aimed at companies and organizations.

And just like other derivatives, this one will have a specific deadline to end, and until the end the investor and the other party will be linked.

With this type of financial transaction, investors can protect themselves from possible risks, but still have some prediction about the returns of both parties.

Generally, negotiations are made on the over-the-counter market, also called over the counter, where the agreement is made directly between companies.

Because of this, they do not have standardized contracts, with the terms and conditions of the agreement being made directly with the companies and their legal team.

And we cannot fail to mention that swaps are quite complex, and end up bringing some credit and liquidity risks.

Future market 

While the futures market takes place, of course, in the future. Therefore, the contract is made between two parties who have an obligation to buy or sell an asset on a specific date.

These contracts usually have a future end date, like an expiration date, and their prices vary according to the days. 

One of the benefits of this type of derivative is that it can be liquidated before maturity.

This is because as their values fluctuate over the days, the investor can liquidate the asset when he thinks it is more advantageous.

However, there is no way to predict the market very well, and the result can be a loss or a gain.

Options market

As we can see, other forms of purchasing involve obligations directly with other people, which must be fulfilled.

In this case, the investor can exercise his right to sell or buy a share or financial asset, which will be done at a fixed price in the future.

The main, and only, obligation of the investor is to buy the share in order to enter the options market, that is, he needs to buy a “premium” from whoever is selling.

With this premium you will have the possibility of buying the share or asset in the future for the amount agreed upon between the two parties, investor and seller.

But since there is no obligation to comply, when the time comes to buy the asset you can choose whether or not you want to, it is up to you.

The only thing that will happen is that you will lose the prize amount which cannot be refunded.

How to invest in derivatives?

A great tip for starting to invest in the derivatives market is to look for an investment broker. They act as an intermediary between you and the actions that will be bought or sold.

Be very careful when choosing a broker as fees are usually charged per trade, try not to go with very expensive brokers.

Try to study the financial market and other terms used before you start investing in different assets, whether physical or not. Studies in the areas of the financial market never end, so stay up to date!