CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 82.67% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money

Why buy derivatives?

There are two main reasons for buying derivatives: speculation and hedging. Some securities, like contracts for difference, can also offer investors a way to trade in assets without the need to physically own that asset – for example, you can buy or sell the price of crude oil, without having to make room in your garage for all those barrels!

Many institutional investors include a number of derivative financial instruments in their portfolios. They don’t tend up make up the core of a portfolio, these are typically safer assets, such as government bonds, which are there to provide a secure, albeit low-yielding annual income.

Instead, derivative contracts are seen as so-called ‘satellite holdings’ – things that investors can have a bit of a gamble with to try and make bigger, or higher-yield, returns. This is speculation.

Investment derivatives can be used to offset some of the risk already present in a portfolio – and this is called hedging. For example, if a portfolio contains corporate bonds, credit default swaps can be used as insurance against default on those bonds.

There are many other examples of hedging, but let’s come back to that – and look now at some of the different types of derivative in a bit more detail. First, let’s examine some of the more common products that are easier to trade and understand.

Test yourself

What are the two main reason for buying derivatives?

Dividends and hedging
All answers provided are correct
Speculation and hedging
Speculation and dividends
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Contract for difference

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Trading Glossary

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That's the number of terms in our glossary.


Do you know your CFDs from your IPOs or ETFs? Remove the mystery with our definitions glossary.

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Term of the day

International Securities Identification Number (ISIN)

ISIN stands for International Securities Identification Number this is an alphanumeric code with 12 characters that can be issued for shares, bonds, options, derivatives and futures. For example, Apple’s ISIN is US0378331005....

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The most common word

Financial Times Stock Exchange (Footsie)

The FTSE 100 definition is the same as the definition of the Financial Times Stock Exchange 100 Index, with the FTSE 100, or Footsie, being shortened names (or slang names) for the stock market index . The index comprises the top 100...

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