Comprehensive Guide to Derivatives: The Five Major Types of Commodities, Trading Methods, and Risk Awareness

What Are Derivative Instruments? A Core Concept Overview

Looking back at the world of financial investment, we have encountered various assets such as stocks, foreign exchange, commodities, indices, and virtual currencies. Derivative instruments are financial contracts derived from these underlying assets.

Derivative Instruments (Derivatives) are essentially tradable financial contracts whose value depends entirely on the price movements of the underlying assets. When stocks, bonds, commodities, indices, or interest rates fluctuate, the prices of derivatives tracking these assets also change accordingly.

For example, if you want to invest in 1 BTC (assuming the current price is $95,000), the traditional approach is to buy Bitcoin directly on an exchange and wait for appreciation. But through derivatives, such as Bitcoin CFDs, you only need to deposit a small margin to control an equivalent Bitcoin exposure—that’s the core appeal of derivatives: achieving greater investment effects with less capital.

Three Major Features of Derivative Instruments

⭐ Leverage Effect — Participate in large trades with a small margin, greatly increasing trading flexibility

⭐ Two-Way Trading Mechanism — Can go long or short without holding the actual asset

⭐ Hedging Function — Used to mitigate market volatility risks and also offers speculative profit opportunities

Why Trade Derivative Instruments? Three Core Drivers

Risk Hedging

Many large enterprises use derivatives to hedge operational risks. For example, oil companies lock in oil prices with futures, import/export firms hedge exchange rate fluctuations with forward contracts, and agricultural producers protect themselves from price crashes through futures trading.

Speculative Profits

The high leverage characteristic of derivatives allows investors to make big gains from small investments. By predicting asset price trends, speculators can amplify returns in a short period. Since only a margin deposit is required, even small capital can engage in large-scale trading.

Arbitrage Opportunities

In futures markets, sharp traders look for arbitrage opportunities based on upstream and downstream industry chain relationships. For example, when iron ore prices fall, they can anticipate steel prices will also decline and implement corresponding trading strategies.

Advantages and Risks of Derivative Instruments

Advantages

High Liquidity — Derivatives can be traded on exchanges or OTC markets, offering numerous trading opportunities and strong market liquidity

Low Trading Costs — Futures, options, and other derivatives typically have lower commissions than directly purchasing the underlying assets, and no stamp duty is required

Flexible Allocation — Investors can adjust leverage, trading volume, and holding periods according to their risk tolerance

Hedging Tools — Effectively hedge against interest rate risk, exchange rate risk, price risk, and other market risks

Risks

High Volatility — Derivative prices fluctuate sharply, and in extreme cases, valuation can be inaccurate

Liquidation Risk — Leverage is a double-edged sword; adverse market movements can lead to rapid losses or even total loss of capital

Complex Mechanisms — Rules and strategies are relatively complicated; lack of professional knowledge can lead to pitfalls

Counterparty Risk — Especially in OTC trading, the counterparty may default on the contract obligations

Five Main Types of Derivative Instruments

① Futures Contracts

Futures give investors the obligation to buy or sell at a predetermined price at a future date.

Features:

• Standardized contracts, regulated by exchanges, facilitating centralized bidding
• Require margin deposits, amplifying both gains and losses
• Must be closed or settled in cash before expiration; unlimited holding is not allowed
• Futures brokers will force close open positions at expiration

Note: Margin requirements tend to increase as expiration approaches; individual investors should avoid holding contracts close to expiry.

② Options (also called Warrants)

Options give the buyer the right (not obligation) to buy or sell an asset at a specified price on a future date.

Features:

• Standardized instruments with uniform contract terms
• Require margin deposits, with higher leverage
• Divided into call options and put options; can be combined to build complex strategies
• Time decay is significant; value drops rapidly as expiration nears

Note: Options are complex; most options expire worthless. Profitable trading requires executing strategies before expiration.

③ Contracts for Difference (CFDs)

CFDs allow investors to trade based on asset price movements without owning the actual asset.

Features:

• Non-standardized, OTC contracts with flexible specifications
• Very high leverage; investors only need to deposit a small fraction of the contract value
• No expiration date; can be held indefinitely
• Can go long or short, with low entry barriers

Note: OTC trading carries higher risks; choose regulated, reputable platforms. Some assets may have low liquidity, leading to price jumps.

④ Forward Contracts

Forwards are private agreements between two parties to buy or sell an asset at a future date at a predetermined price.

Features:

• Fully customized, non-standardized contracts tailored to needs
• Usually long-term, suitable for long-term risk management
• Flexible trading without intermediaries

Note: Counterparty risk exists; one party may default. Market liquidity is often low.

⑤ Swaps

Swaps are agreements where two parties exchange future cash flows under agreed conditions.

Common types include interest rate swaps, currency swaps, and commodity swaps. For example, currency swaps involve exchanging principal in different currencies, helping hedge exchange rate risk.

Features:

• Non-standardized, negotiated between parties
• Long-term contracts involving future exchanges
• Highly customizable with flexible terms

Note: Usually used by financial institutions; complex and often require legal and regulatory compliance, with higher transaction costs.

Key Differences: Derivatives vs. Stock Trading

Who Is Suitable for Trading Derivatives?

Enterprises and Producers — Oil companies, gold miners, agricultural producers, etc., can lock in commodity prices via futures to hedge against market volatility

Hedge Funds and Asset Managers — Use derivatives to leverage investment portfolios and hedge positions

Short-term Traders and Individual Investors — Use leverage to speculate and quickly increase profits

Risk Management Seekers — Any investor needing to hedge specific risk exposures

Where to Trade Derivatives?

Centralized Exchanges

Most brokerages and futures firms offer futures, options, and other derivatives. These contracts are strictly regulated, with clear trading rules and oversight. However, trading restrictions are often strict, with high minimum trading volumes.

OTC Markets

Also called over-the-counter markets, where contracts are directly executed between two parties. Non-standardized, with fewer restrictions and lower costs. But counterparty risk is higher; ensure the platform is regulated and reputable. Some assets may have low liquidity, leading to price jumps.

Key Principles for Choosing a Platform

When trading derivatives, always select a regulated, reputable platform. Prioritize the following factors:

• Regulatory License — Confirm the platform holds licenses from authoritative regulators (e.g., FCA, ASIC)
• Trading Costs — Compare spreads, commissions, overnight fees, and overall costs
• Product Range — Ensure the platform offers the derivatives and underlying assets you want
• Technical Stability — The trading system should be stable, fast, and support multiple trading methods
• Customer Protection — Understand protections like negative balance protection and fund segregation

Three Steps for Beginners

Step 1 — Clarify your trading goals: Hedging risk or speculative profit? Different goals require different derivatives

Step 2 — Learn the basics: Deeply understand the specific instruments you plan to trade (futures, options, CFDs), including their mechanisms, risks, and fee structures

Step 3 — Start small: Open an account on a regulated platform, begin with small capital and low leverage, and gradually gain experience

Summary

Derivatives are a vital part of modern financial markets, offering ways to hedge risks and pursue speculative profits. However, their high leverage, complex rules, and market risks should not be underestimated. Investors should thoroughly understand the characteristics of various derivatives, choose regulated platforms, start with small capital, and accumulate trading experience step by step. Derivatives themselves are neither good nor bad; the key lies in whether investors possess sufficient knowledge and risk awareness to manage them effectively.