What is spot trading? The truth behind derivatives

Contemporary investment markets offer a dazzling array of tools, from holding physical gold to indirect participation through funds, and to using derivatives for long or short positions—control is in the hands of investors. Among all financial instruments, derivatives are renowned for their high-risk nature. However, not many investors truly understand what are derivatives; this is why some achieve financial freedom through derivatives, while others suffer devastating losses. Today, we will unveil the mysteries of derivatives.

The Essence of Derivatives: Future-Based Trading Commitments

ตราสารอนุพันธ์ or Derivative is essentially a financial contract signed today that involves the right to deliver or trade an underlying asset in the future. Unlike direct purchase of the commodity, derivatives allow buyers and sellers to lock in future prices and quantities today, even if neither party owns the asset at the moment.

This mechanism has a clever feature: the price of derivatives can reflect market expectations of future prices in real-time. When the price of the underlying fluctuates during the delivery period, traders have the opportunity to profit from price differences. For example, the December 2020 futures contract for West Texas Intermediate (WTI) crude oil was agreed at $40 per barrel—meaning that by the end of December, regardless of spot oil prices, the delivery price remains $40. The seller gains sales certainty, and the buyer ensures predictable costs.

Detailed Explanation of Five Types of Derivative Tools

1. Forwards — Over-the-counter flexible options

Forwards are the simplest form: the buyer and seller negotiate directly, agreeing on future delivery date, price, and quantity today, then settle at the agreed date. As a peer-to-peer transaction, liquidity is lower, but they are widely used for hedging risks in agricultural products and commodities.

Advantages: Highly customizable, precisely meets hedging needs
Disadvantages: Poor liquidity, unsuitable for frequent trading; delivery risk

2. Futures — Standardized market platform

Futures are an upgraded version of forwards. They standardize delivery quantities, are traded on exchanges, and involve many participants, resulting in much higher liquidity than forwards. From Brent crude oil to COMEX gold and various crypto futures, they operate on different specialized exchanges.

Advantages: High liquidity, standardized contracts, transparent trading
Disadvantages: Possible forced delivery; minimum contract sizes are large, unsuitable for small investors

3. Options — The buyer’s insurance policy

Options give the holder a right: to buy or sell the underlying asset at an agreed price on a future date—but you are not obliged to exercise this right. To acquire this right, the buyer pays a “premium”; the seller receives the premium and bears the obligation to perform if the option is exercised.

Advantages: Limited risk (maximum loss is the premium), unlimited profit potential, flexible strategies
Disadvantages: Requires in-depth understanding of pricing models; poor strategy choices can limit gains and increase risk exposure

4. Swaps — Reallocation of cash flows

Swap agreements are commitments between two parties to exchange future cash flows. Unlike other derivatives, they are mainly used to hedge interest rate and exchange rate risks, not commodity prices. They enable companies to alter the nature of their cash flows without changing the underlying assets.

Advantages: Effective management of interest rate and liquidity risks
Disadvantages: High entry barriers, limited liquidity, mostly OTC trading

5. Contracts for Difference (CFD) — The new favorite of zero-sum games

CFD differs from the first four in that: it involves no actual delivery. You trade the price difference of the underlying asset; profit or loss = difference between opening and closing prices × position size. CFDs allow both long and short positions, often with high leverage. This makes it resemble both futures trading and gambling—depending on how you use it.

Advantages: High leverage, ability to short, low trading costs, 24-hour liquidity
Disadvantages: Losses can be magnified; zero-sum nature; unsuitable for long-term holding

Why Are Derivatives Popular Among Investors

Lock in future gains

Through ตราสารอนุพันธ์, derivatives allow you to lock in future transaction prices today. Regardless of market fluctuations, your costs or selling prices are fixed, which is crucial for risk-averse investors.

Hedge portfolio risks

Suppose you hold 100 ounces of gold but worry about falling prices. Instead of incurring transaction costs from selling, you can hedge by shorting futures or buying put options. This is especially useful during market turbulence.

Expand investment scope

Derivatives enable participation in price movements without owning the underlying assets. You can trade oil, gold, cryptocurrencies, etc., without holding these difficult-to-store or transport items. This significantly lowers the barrier to entering high-end asset markets.

Profit from price differences

For short-term traders, CFDs and futures are excellent tools. High liquidity combined with low transaction costs makes it easier to profit from price fluctuations.

The Real Risks of Derivatives — Must Know

Leverage is a double-edged sword

Using leverage means you only need to invest a small part of the total position. It amplifies potential gains but also magnifies losses. If the market moves unfavorably, your account balance can evaporate instantly. Traders without stop-loss or trailing stop orders often go bankrupt this way. Choosing brokers with “negative balance protection” is crucial.

Delivery risk

Some derivatives (like futures and forwards) require actual delivery at expiration. If you do not fully understand or prepare, you may be forced to accept or deliver physical goods, which involves storage, transportation, and quality inspection issues.

Market volatility risk

Economic data releases, central bank policy adjustments, geopolitical events—all can cause sharp market swings. Assets sensitive to interest rates (like gold) can plummet when the Fed announces rate hikes, and leverage accelerates this process. Traders unprepared for such volatility often get wiped out.

Counterparty risk

In OTC derivatives (like forwards, swaps), the counterparty may default on their obligations. This was especially evident during financial crises—many companies suffered huge losses due to counterparty defaults.

Derivative Usage Checklist

To use derivatives safely, remember these points:

1. Choose regulated platforms: Ensure brokers have proper licenses and offer negative balance protection
2. Start small: Don’t use maximum leverage immediately; gradually adapt to the market
3. Set stop-loss orders: Always set stop-loss points regardless of confidence in trades
4. Understand what you’re trading: Don’t follow blindly; deeply learn the characteristics of derivatives
5. Regularly assess risk tolerance: Markets change, and your strategies should adapt accordingly
6. Keep learning: The derivatives market is constantly evolving; continuous education is vital

Summary: Derivatives Are Neither Evil nor Angelic

ตราสารอนุพันธ์ or Derivative—what exactly is it? Simply put, it is a future-based financial contract that can help hedge risks, speculate for profit, and expand investment scope. But it also carries high risks.

Some multiply their assets through derivatives, while others go bankrupt due to misuse. The key is not the tool itself but whether you understand its mechanisms, assess risks, set rules, and adhere to risk management principles.

Once you have a clear understanding of the pros and cons of derivatives, you can better utilize these powerful tools according to your risk tolerance and investment goals.

Quick FAQs

Where are derivatives traded?
It depends on the specific type. Standardized derivatives (futures, exchange options) are traded on centralized exchanges; OTC derivatives (forwards, swaps, OTC options) are traded point-to-point via brokers. Some platforms also offer crypto derivatives trading.

Are stock options also derivatives?
Yes. Stock options give the holder the right to buy or sell stocks at a specific price on a specific date, and their value is entirely based on the underlying stock price. This is the definition of derivatives—their value derives from other assets.