Bullish Bears Logo
Make Money Trading Derivatives

Make Money Trading Derivatives

7 min read

So, how exactly does one make money trading derivatives? It doesn’t sound very easy, but it’s quite simple. Follow simple game rules, educate yourself, and pick a strategy. Then profits will follow. Before we get there, it’s important to understand what a derivative is. 

A derivative is also known as a financial security. The derivative itself is a contract between two or more parties. And the derivative derives its price from fluctuations in the underlying asset.

In this context, the term “security” refers to a financial instrument that is fungible and negotiable while holding some type of monetary value.

It represents an ownership position in a publicly-traded corporation via stock, a creditor relationship with a governmental body, or a corporation represented by owning that entity’s bond or ownership rights as defined by an option.

Make Money Trading Derivatives

Value and Price to Make Money Trading Derivatives

A derivative’s value depends on or is derived from an underlying asset or group of assets referred to as a benchmark.

So what price does a derivative depend to make money trading derivatives? The derivative derives its price from fluctuations in the underlying asset. 

Common Underlying Assets for Derivatives

The most common underlying assets for derivatives are the following:

  • Stocks
  • Bonds
  • Commodities
  • Currencies
  • Interest rates
  • Market indexes

Why Do We Trade Derivatives?

For many reasons. You can make money trading derivatives, so why wouldn’t you want to? For some, it’s just preference. On the other hand, you might have a smaller account and want to use the leverage they offer.

Depending on the type of derivative, you can use them for risk management, speculation, and leverage.

Common Way to Trade Derivatives

Derivatives commonly trade OTC (over-the-counter) or on an exchange. On the whole, we mainly trade derivatives OTC. However, one major downside of OTC-traded derivatives is their high potential for counterparty risk. For those of you unfamiliar with counterparty risk, let me explain. 

Counterparty risk is the danger that one of the two parties involved in the trade might default. And the answer as to why comes as no surprise. The trades happen between two unregulated private parties.

Conversely, if counterparty risk concerns you, stick with exchange-traded derivatives. Fortunately, exchange-traded derivatives are not only standardized but heavily regulated.

SERVICES
Trading Rooms Stock Signals and Trading Alerts Stock Watch Lists
DESCRIPTION Bullish Bears offer trade rooms in our Discord. Our chat rooms include penny stocks, large caps, options, and futures We offer stock signals and trade alerts through our watch lists and Discord bots using Tradytics Swing trade and day trade watch lists with hand-picked symbols that have the best chance of breakouts. These are stocks to watch
INCLUDED

Common Forms of Derivatives

Did you know that the derivative market is growing and offers products to fit nearly any need, budget, or risk tolerance? With everything from futures to forwards, swaps, and options, anyone with little training can make money trading derivatives. 

Let’s break it down with a few examples.

Let’s Talk Futures Derivatives

Futures are exchange-traded derivatives —also known as futures—contracts that lock in the delivery of a commodity or security in the future at a price set today.

Traders utilize futures contracts for many reasons, such as to hedge their risk or even speculate on the price of an underlying asset. 

Both parties (the buyer and seller) of the futures contract must fulfill their contractual obligations on the settlement date.

Regardless of the price at expiration, the buyer must buy, or the seller must sell at the pre-determined price. 

Derivative Trading Example

Let’s take a real-life example of someone making money trading futures derivatives. On November 6th, 2019, my company purchased a futures contract on oil. We’re anticipating an increase in demand and a price increase in December. We’re being wise and wanting to lock in a price before they go up. The contract, which expires on December 19th, 2019, costs me $62.22 a barrel. Our oil futures contract hedges our risk against a rise in price as the seller is obligated to deliver the oil to us at $62.22 a barrel by December 19th, 2019.

Hence, oil prices rose to $80 on December 19th, 2019. Unfortunately, the seller on the other side of the contract has to deliver the oil to me at $62.22 a barrel.

At this point, I have one of two options. I can accept the oil delivery from the futures contract’s seller. But what if I no longer need it? Since I have no use for the oil, I can sell the contract before expiration and keep the profits. How awesome is that!

In the scenario above, it’s possible both the buyer and the seller of the oil futures contract were hedging their risk or bets. We’re both trying to minimize the risk of being wrong or incurring loss by pursuing two courses of action simultaneously.

My company needs oil in December, but I’m worried prices will skyrocket, so I buy a long position, hedging my bets. Conversely, the seller could be an oil company worried about falling oil prices. 

Consequently, they want to eliminate that risk by selling or “shorting” a futures contract that fixed the price in December.

Speculating

We also have another possible scenario. What if both the buyer and seller of the futures contract were speculators?

Both have the opposite opinion about the direction of December oil. If both were speculators, it’s unlikely they would want to deliver or have to accept oil barrels at homes.

As speculators, they have a ticket out of jail card. Luckily, they can end their obligation to buy or deliver the underlying commodity. They accomplish this by closing or “unwinding” their contract before the expiration date with an offsetting contract.

Have I lost you yet? Don’t worry; I’ll explain this in detail below.

For example, the futures contract for West Texas Intermediate (WTI) oil equals 1,000 barrels of oil. What if the price of oil rose from $62.22 to $80 per barrel? 

For starters, the trader with the long position- the buyer (me)- in the futures contract would have profited $17,780 [($80 – $62.22) X 1,000 = $17,780]. Yay!!! Conversely, the trader in the short position—the contract seller—would have lost $17,780.

Final Thoughts: Make Money Trading Derivatives

Not all futures contracts get settled at expiration by delivering the underlying asset. Who wants 1000 barrels of oil showing up at their doorstep? Not me, thanks. Because of this, most derivatives are cash-settled. 

To summarize, the gain or loss in the trade shows up in the trader’s brokerage account. Along the same token, many Futures contracts are cash-settled.

These include interest rate futures, stock index futures, and even volatility and weather futures.

Can you make money trading derivatives? While trading derivatives may seem complicated at a glance, it doesn’t have to be. Now, I only talked about futures derivatives on oil. But you can easily trade options contracts on stocks like FacebookOne of the ways to limit risks with derivatives is by trading spreads, such as call credit spreads. I would look into them if you’d like to get more into the world of options.

Related Articles

What Is a Pullback

What Is a Pullback?

Have you ever wondered why some stocks temporarily drop in value after an upward trend? This is called a pullback, a temporary decline that can

Read More »
Floating Stock

Floating Stock Definition

Have you ever noticed companies with large bid-ask spreads? There is a significant difference between a stock’s buying and selling price. What is the reason

Read More »

FREE ONLINE TRADING COURSES

If you’ve looked for trading education elsewhere then you’ll notice that it can be very costly.

We are opposed to charging ridiculous amounts to access experience and quality information. 

That being said, our website is a great resource for traders or investors of all levels to learn about day trading stocks, futures, and options. Swing trading too! 

On our site, you will find thousands of dollars worth of free online trading courses, tutorials, and reviews.

We put all of the tools available to traders to the test and give you first-hand experience in stock trading you won’t find elsewhere.

Our content is packed with the essential knowledge that’s needed to help you to become a successful trader.

It’s important to treat day trading stocks, options, futures, and swing trading like you would with getting a professional degree, a new trade, or starting any new career.

Invest the proper time into your Trading Education and don’t try to run before you learn to crawl. Trading stocks is not a get-rich-quick scheme. It’s not gambling either, though there are people who treat it this way. Don’t be that person! 

STOCK TRADING COURSES FOR BEGINNERS

The Bullish Bears team focuses on keeping things as simple as possible in our online trading courses and chat rooms. We provide our members with courses of all different trading levels and topics.

If you’re a beginner, intermediate level, or looking for expert trading knowledge…we’ve got you covered. 

We have a basic stock trading course, swing trading course, 2 day trading courses, 2 options courses, 2 candlesticks courses, and broker courses to help you get started. Free.

Just choose the course level that you’re most interested in and get started on the right path now. Become a leader, not a follower. When you’re ready you can join our chat rooms and access our Next Level training library. No rush. We’re here to help.

Click Here to take our free courses.