Derivatives markets are markets that are based upon another market, which is known as the underlying market. Derivatives markets can be based upon almost any underlying market, including individual stock markets (e.g. the stock of company XYZ), stock indices (e.g. the Nasdaq 100 stock index), and currency markets (i.e. the forex markets).
Types of Derivatives Markets
Derivatives markets take many different forms, some of which are traded in the usual manner (i.e. the same as their underlying market), but some of which are traded quite differently (i.e. not the same as their underlying market). The following are the most often traded types of derivatives markets:
- Futures Markets
- Options Markets
- Warrants Markets
- Contract For Difference (CFD) Markets
- Spread Betting
Trading Derivatives Markets
Of the above types of derivatives markets, futures markets and contract for difference markets are traded in the same manner as their underlying markets, but options markets and warrants markets are traded differently from their underlying markets. For example, futures markets are traded by making a long trade when the market is expected to move upwards, and a short trade when the market is expected to move downwards, whereas options markets can be traded by making either a long trade or a short trade when the market is expected to move upwards. Spread betting is different from both groups of derivatives markets because it is classified as gambling rather than trading, and therefore can be traded in several different forms (e.g. spread betting, binary betting, etc.).
Differences Between Derivatives Markets
A single underlying market usually has several different derivatives markets, which provides several choices for trading a particular market. For example, the FTSE 100 stock index can be traded via futures markets, options markets, warrants markets, contract for difference markets, and spread betting markets. The different derivatives markets for a single underlying market usually have different tick sizes, tick values, and margin requirements, which allows a single underlying market to be traded using a variety of different trading configurations (e.g. different amounts of risk, different amounts of trading capital, etc.).