Investing isn’t just about buying stocks…

Investing isn’t just about buying stocks like a Wall Street hotshot or parking money in bonds like your grandparents. The financial world has evolved, bringing new ways to grow your money. Today, investors can tap into stocks, commodities, real estate, cryptocurrencies, and even sports teams. But what if you could trade these assets without owning them? That’s where derivatives come in.

So, what exactly are derivatives, and why do so many people trade them?

What are Derivatives?

Derivatives are contracts that track the price of an asset—whether it’s gold, oil, a stock, or an index. Instead of owning the asset, you trade a contract that mirrors its price movements.

Why use them? Cost and flexibility. Imagine gold is trading at $3,000 (R55,000) per ounce. If you wanted to profit from price changes, you’d have to buy and store physical gold—not exactly convenient.

With derivatives, you can trade gold for a fraction of the cost using leverage, meaning a small deposit gives you exposure to a much larger position.

What are futures, options and forwards?

Futures, forwards, and options are financial tools that help individuals and businesses manage the risk of price changes in various markets.

Futures Contracts are agreements to buy or sell an asset (like oil, gold, or wheat) at a predetermined price on a specific future date. Futures are standardised and traded on exchanges, providing a structured way to hedge against price fluctuations.

Imagine you’re a farmer expecting to harvest wheat in six months. You’re concerned that wheat prices might drop by the time you sell your crop. To protect yourself, you enter a standardised futures contract to sell your wheat at today’s price, ensuring you receive a predictable income regardless of market changes.

Forward Contracts are like futures, these agreements set the terms to buy or sell an asset at a future date for a price agreed upon today. However, forwards are private, customisable contracts between two parties and are not traded on exchanges, which can introduce additional risks.

Suppose you own a coffee shop and anticipate that coffee bean prices will rise in the next three months. To secure a stable cost, you negotiate a forward contract with a supplier to purchase coffee beans at the current price, to be delivered three months later. This arrangement helps you manage your expenses despite potential market volatility.

Options Contracts provide the holder with the right, but not the obligation, to buy (call option) or sell (put option) an asset at a predetermined price within a specific time frame. To acquire this right, the buyer pays an upfront premium.

Consider you’re an investor who believes that a particular stock, currently priced at $50, will increase in value over the next three months. You purchase a call option for $2 that allows you to buy the stock at $52 during this period. If the stock’s price rises to $60, you can exercise your option to buy at $52 and profit $8 from the difference minus the option premium, giving you a total profit of $6. If the price falls, you can choose not to exercise the option, limiting your loss to the premium paid.

What is a CFD, and why are they so popular?

A Contract for Difference (CFD) lets you trade an asset without owning it, profiting from price changes. If the price moves in your favour, you win. If it moves against you, you lose.

CFDs are popular because of leverage. With a small upfront deposit, you can control a much larger position, making them a low-cost and flexible way to trade stocks, currencies, commodities, and indices. Plus, you can go long or short, meaning you can profit in both rising and falling markets.

But leverage is a double-edged sword. A small market move against you can wipe out your investment fast, and if your balance drops too low, you’ll need to top up or close your trade. Used wisely, CFDs can be a powerful tool, but without discipline, they can lead to major losses.

Why Do Derivatives Matter in Investing?

Derivatives aren’t just for traders looking to make a quick profit. They’re essential to modern finance, helping businesses manage risk, allowing investors to capitalize on market moves, and adding liquidity to global financial markets.

Used correctly, they can enhance portfolios and hedge against uncertainty. But they require knowledge, strategy, and risk management. In the right hands, they’re powerful tools. In the wrong hands, they can be dangerous. The key is knowing what you’re doing before you jump in.