How to Trade Stock Derivatives

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For those experienced with the basics of stock market trading, the derivatives world offers a whole new challenge and many new ways to make money. Stock derivatives can take many forms, but all essentially establish a contract between a stock-owning party and an investor who wants to purchase stocks at a later date. You can purchase derivatives through many brokerage firms or even create your own, referred to as writing a derivative.

  • Open an investment account with a brokerage firm either in your area or online. Research the brokerage firm first to ensure that it trades in stock derivatives.

  • Purchase one or more stock derivatives. Contact your brokerage firm and ask them about the opportunity to purchase derivatives in stocks which interest you. Brokerage firms involved in derivatives trading can draw up a derivatives contract creating the derivative for a fee.

    There are various types of stock derivatives that can be purchased on the open market, including options, warrants, futures and forwards. A stock option gives an investor the right to purchase a certain number of stock shares at an agreed-upon future date at the strike price, or the stock's price at the time that the option was purchased. A warrant is similar to an option but sold directly by a company to an investor. A future also establishes a stock purchase at a future date but obligates the investor to buy shares instead of giving them the opportunity to decline the purchase like an option provides. A stock forward is similar to a future derivative but limits the future transaction to stocks and cash instead of other assets.

  • Sell your stock derivative contract to an interested buyer through your brokerage firm. In many cases, selling a derivative, or even short selling it at a lower price, is easier to accomplish and less regulated than short selling stock, as a derivative is a paper contract which is not tied to a stock (although it establishes the right to purchase that stock).

  • Sell your own stock derivatives by writing a call on stock which you already own. When writing a call, an investor enters into an agreement with another investor to sell a certain amount of shares in the future at the strike price. Calls may be covered, meaning that the investor writing the call owns the stock, or uncovered, which means that the investor does not possess the stock and must purchase it if the other party exercises the right to purchase the stock. Discuss the options you have for writing stock calls with your brokerage firm; there will likely be another fee to complete the transaction.

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