What is a derivative?

For those of you who've always wanted to know "what is a derivative", I will do everything to explain this issue in the simplest ways.

Undoubtedly, derivatives are one of the things that gets lots of attention to Journal, but is poorly understood by the masses. Even those who specialize in the financing, including CFOs, accountants and notaries do not fully understand this issue. But understanding the basic concept behind a derivative need not be a complex task.

Almost all of us have used a credit card at least once throughout our lives. Indeed, in today's world, almost never need to carry around a wad of cold, hard cash, physics. In this context, we consider the credit card as a secondary instrument. Technically, a credit card is simply a value piece of plastic with some numbers that plastered on it. And even credit cards have become as prevalent in our society, and much more than cash company mainly because credit cards come with the support of the credit card itself.

For this reason, we view a credit card as a ' derivative ' of cash. This may be different. This may feel differently. But serves the same purpose as cash. Furthermore, even many will say that a credit card is better than cash rewards and benefits offered. Also, the loss of your credit card number is never as bad as losing physical cash. If you lose your credit card, the card company immediately to deactivate your card. Finally, credit cards allow users to repay outstanding debts within a certain time frame without any interest. How big is this?

Make no mistake, however, you may also subscribe with a credit card in ways which ' cash ' is not possible. In General, you never want to lose a credit card payment or penalties for late payment can be exorbitant.

So, just as consumers can use the ' credit ' instead of ' cash ', investors use derivatives without the need to purchase the shares outright.

One reason why an investor can choose a derivative instrument is the fact that derivatives often require less of an initial cash outlay. If IBM stock trades at $ 100, this means that the investor must have $ 10,000 to buy 100 shares of IBM.

A derivative game such as a call option, on the other hand, may require only 1/10th of that amount (ie. $ 1,000). This is a great strategy for investors who do not want to expose themselves to more than $ 1,000.

Of course, the call options have the dark side. One is "hour". Dialing options expire after a certain date or expired. technically shares can last forever. For example, a 100 July 2011 the IBM call option is a call option in IBM stock, which expires in July 2011. This call is only value at the date of expiry of the July 2011 If IBM trades at more than $ 100. «July 2011 is known as ' ' end date ' ' and ' $ 100 is known as the ' strike price ' . If IBM happens to trade stock under $ 100, from the date of expiry, the call option expires worthless.

Another disadvantage is that these options require investors to pay a ' premium ' . Investors lose their entire premium, essentially if the call is without value at the date of expiry.

Another derivative instrument called right. As an option call right will have expiration dates in particular and the strike price. Right is interesting in that it allows investors to secure or to protect their portfolios from falling share prices. Many life insurance companies and banks to put strategies when designing principal protected investment/notes.

Technically, puts and calls are the building blocks for almost every derivatives strategies. The key point to remember is that the options that come with different strike prices and expiration dates for different associated with them. So in the example above, we talked about an IBM 100 call July 2011. Similarly, there will be call options with a strike price of $ 105, $ 110, $ 115, and so on. And, similarly, you can get dialing options with maturity dates August 2011, Mar 2011, September 2011, and so on.

While I will not go into and out of all possible derivatives strategies, knowing the important point is that there are any number of derivatives strategies can create different levels of profits.

Just as an artist creates hundreds and thousands of colors from three primary colors, red, blue and yellow, so too is the nature of the derivatives.