1. Speculation - This is extremely risky and this is the one that gives derivatives the bad name.
2. Hedging - This in fact is meant to reduce your risks.
3. Arbitrage - This is absolutely ZERO RISK way to make money - It is safer than investing even in Govt. Bonds theoretically.
So it all depend on how you use derivatives that will determine whether you will make money or kill yourself. By itself Derivatives are not bad. It is a very powerful weapon and like all powerful weapons, it should be handled carefully. It lets you choose your handling method. Now it is all upto you.
Most retail investors in the Indian market burn their hands because they speculate using derivatives purely on the advice of their brokers. And these brokers have their own axe to grind. They want to churn your portfolio so that they can make more money for themselves. In the bargain the lay investor gets burnt.
RE:Derivatives Usage
by m s mani on Mar 20, 2008 05:07 PM Permalink
Would you please explain more about ARBITRAGE in derivatives,how it is zero risk?? where speculation is involved,how can it be zero-risk??
RE:Derivatives Usage
by Good_man on Mar 16, 2008 08:14 PM Permalink
The real world works on the principle of 'Prey and Predator'. Number and health of predators depends on number of prey available. The time evolution of two species goes in a predictable manner.
If we are able to lure many millions of small investors to put their savings in to stock market by sustained advertising etc, the 'prey' population will be fairly constant, and 'predators' can happily continue to make money.
In fables that we learn as children, a kind hearted man teaches parrots to repeat 'be careful of the hunter'.
Parrots nodoubt learn their lessons well, and when caught irretrievably in the trap, do not forget to chant 'be careful of the hunter'.
If we want to help the situation, and aim for general prosperity, there is enough experience available from advanced economies and overall functioning and behaviour of free market, to rethink about strategies for larger good.
Clever strategies like hedging funds are needed because direct investment is vulnerable to violent ups and downs etc. caused by various things.
Primary markets alone are not generating the wealth, and many more evolved options proliferate. Operators with 'deep' study, (meaning thereby those who have learnt their lessons through numerous 'small gains' and 'large losses') are more comfortable with complexities.
New entrants have no clue whatsoever about overall happenings and readily confess to it, while hoping to make big any how__ by 'speculation' or 'investing' etc.
