Derivatives Advantages and Disadvantages

Derivatives are the most important innovation which has happened in the past few years when it comes to financial markets. It has changed the whole way of operations of stock, commodities and currency market. Given below are some of the advantages and disadvantages of derivatives –

Advantages of Derivatives

  1. Since all transactions related to derivatives take place in future it provides individuals with better opportunities because an individual who want to short some stock for long time can do it only in futures or options hence the biggest benefit of this is that it gives numerous options to an investor or trader to execute all sorts of strategies.
  2. In derivatives market people can transact huge transactions with small amounts and therefore it gives the benefit of leverage and hence even people who have less amount of money can enter into this market.
  3. Intraday traders get the benefit of liquidity as these contracts are very liquid and also the costs such as basis expense, brokerage are less as compared to cash market.
  4. It is a great risk management tool and if applied judiciously it can produce good results and benefit its user.

Disadvantages of Derivatives

  1. Leverage is a double edged sword and therefore if you do not get it right chances are you wound end up losing huge amount of money because these contracts have specific maturities and on that date they get expired unlike cash market where you can hold on to stocks for long period of time.
  2. Since its inception many critics have been blaming derivatives for huge fall which keeps happening frequently after the introduction of derivatives and many people say that it increases unnecessary speculation in the market which is not good for the small retail investors who are the backbone of stock market.
  3. It is quite complex and various strategies of derivatives can be implemented only by an expert and therefore for a layman it is difficult to use this and therefore it limits its usefulness.
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