Investors often choose several instruments in the investment world, including stocks, bonds, and mutual funds.

However, apart from that, there is one investment instrument that people, namely derivative financial instruments, rarely know.

Derivatives are also investment instruments listed on the Indonesia Stock Exchange (IDX) as the other instruments mentioned above.

Derivatives themselves play an important role in protecting risks and taking advantage of fluctuations in asset prices.

This can happen because derivatives as a purchase contracts allow for a predetermined price in the contract that has been made.

So, to understand the meaning, types, and important considerations before engaging in derivative trading as a financial instrument and the risks, consider the following review.

What are Derivatives?

Derivatives are an agreement contract between two/more parties who agree to trade (buy and sell) both assets and commodities.

The contract will later function as a trading object with a price/value that must also be agreed upon by the two parties.

As an investment instrument, this derivative, which consists of several financial products, has been supervised by the stock exchange.

It should be noted that the Commodity Futures Trading Regulatory Agency (BAPPEBTI) will supervise the commodity derivative products.

Types of Derivatives

As mentioned above, derivatives are an investment instrument that is rarely known.

This type of investment is also able to provide high profits for investors.

Therefore, potential investors need to know what are the types of derivatives.

The following are types of derivatives that need to be understood:

1. Futures

In Indonesian, it is referred to as a “future contract” Future is a form of agreement (agreement) between two parties in purchasing and delivering assets at an agreed price in the Future.

The futures contract can be traded through the stock exchange with a contract that already has a standard.

In general, investors will use futures either as a form of protection against risks that may occur or to speculate on the underlying asset’s price.

In this regard, parties participating in futures transactions must fulfill commitments to buy or sell the underlying asset. For those of you who want to read about the meaning of futures trading, you can read the article here.

2. Forwards

Forward is almost the same as a futures contract. However, the difference is that forwards are not traded on the futures exchange as a contract.

The reason is, if you want to get a forward, then investors can find it on over-the-counter (OTC).

When the forward contract is concluded, the buyer and seller have adjusted and determined the derivative’s terms, size, and settlement process.

Being an OTC product, a forward contract provides a greater counterparty risk for both the buyer and the seller.

The counterparty risk is a type of credit risk where the buyer or seller has the opportunity to be unable to fulfill the obligations agreed upon in the contract.

If one of the parties to the contract goes bankrupt, the other party may have no choice; even the position’s value may disappear.

After this forward contract is made, the parties can balance their positions with other counterparties.

Of course, this condition can increase the potential risk of the counterparty because more traders/investors are participating in the same contract.

3. Options

Option Contract or Option gives the buyer the right to buy or sell the underlying asset at a pre-agreed price.

Please note option contracts consist of two types, namely as follows:

• Call option

Call options will give traders and investors the right to agree to buy assets at a certain price and period.

• Put options

Put options will permit traders and investors to agree on selling assets at a certain price and period.

4. Swaps

A swap derivative contract is an agreement that allows for the exchange of cash flows between two parties.

In general, swaps involve the exchange of fixed and floating cash flows.

The most well-known types are interest rate, commodity, and currency swaps.

Derivative Functions

As discussed at the beginning of this article, derivatives play an important role in protecting against risks and profiting from fluctuations in asset prices.

The reason is that derivatives as a purchase contracts do allow for a predetermined price in the contract that has been made.

Besides that role, derivatives also have several other functions that are no less important.

Here are some derivative functions that need to be known and understood, including:

1. Hedging

Derivatives can be used or function to protect the risk of changes in asset prices.

This happens because the commodity derivative contracts are closely related to the underlying commodity products.

The value of a derivative contract will move parallel or in line with the underlying product in the spot market.

Therefore, if one of the parties has exposure from his position in the spot market, he can minimize the risk caused by price changes that occur for products in the spot market by opening a position in the derivatives market.

Please note all of the above steps are then referred to as hedging or hedging.

2. Speculation

Derivatives can also be used for speculative purposes and take advantage of changes in asset prices.

This can happen because contracts in the derivatives market, like in the physical market, also change in price so that people can profit by buying and selling derivative contracts.

There are several ways to settle contracts on derivatives: contract settlement through the physical handover of goods on subsequent days, cash settlement, and settlement through granting the right to buy or sell a product at maturity.

With several ways of settlement above, the possibility of making a profit through speculation becomes very open.

Derivatives in the Crypto World

As a commodity, crypto assets are closely related to derivatives and contracts.

A crypto derivative is a contract or a means of payment (financial) whose value is measured by the underlying asset.

Related to this, the assets used are crypto assets, such as Bitcoin and others.

Several crypto derivatives can be used for risk management, speculation, and increasing positions.

It also includes the types of derivatives in general, including futures contracts, options, and swaps.

Meanwhile, the benefits of trading in crypto derivatives, as with other derivatives, are to protect the value or price of a commodity in the Future.

In addition, derivative instruments can reduce the impact of losses and financial risks on the company.

On the other hand, the risk of crypto derivative trading is closely related to its function as a means of speculation.

Given that this type of investment has a high-risk nature and market movements that are difficult to predict, excessive speculation can pose a large risk of loss.

Advantages and Risks of Derivatives Trading

As with other investment instruments, derivatives trading also has advantages and risks.

Some of the advantages of trading in derivatives are related to the benefits of using this investment instrument, including hedging and speculation opportunities.

Derivatives can be used to protect the risk of changes in asset prices.

This is because derivative commodity contracts are closely related to the underlying commodity or product.

In addition, the value of a derivative contract will move in line with the underlying product in the spot market.

In this case, derivatives can then be used for speculative purposes and take advantage of changes in asset prices.

Meanwhile, several risks are associated with trading in derivatives, including price volatility and security risks.

This is because derivatives will usually use price predictions that exist in the Future.

Therefore, this one investment instrument will certainly have a higher risk.

The risks associated with trading in derivatives are related to security risks, so deeper research is needed regarding the products.

Important Considerations Before Engaging in Derivatives Trading

Derivatives trading can provide big profits for investors involved in it.

However, of course, this type of investment instrument also has a risk of loss.

Therefore, careful consideration is needed before deciding to engage in derivative trading.

The following are some important considerations that must be considered, including:

1. Good understanding of the risks associated with derivatives

The first consideration is the importance of understanding the risks associated with derivatives.

In this case, it is important to research and gain in-depth knowledge before engaging in derivatives trading.

2. Consult a competent financial advisor

Before starting trading derivatives, it is also important to consult a competent financial advisor.

This is important because it relates to getting good information and advice regarding this investment instrument.

Conclusion

In conclusion, although less popular, derivatives play an important role as a financial instrument.

This important role is related to derivatives that can protect against risks and take advantage of fluctuations in asset prices.

This can happen because derivatives as a purchase contracts allow for a predetermined price in the contract that has been made.

However, behind the large functions, benefits, and advantages, there are still risks behind it, including those related to price volatility and security risks.

Therefore, taking a cautious approach in trading derivatives is very important.

This includes having a good understanding of the risks associated with derivatives and consulting a competent financial advisor.

So, that was a complete discussion on derivatives, starting from their meaning, function, and benefits, and you can also read other interesting articles about how to learn crypto for beginners only at INDODAX Academy.