Futures and options are called derivative
investments, because their value depends on the value
of an underlying
investment, such as a stock or commodity — or
raw material. You can think of futures and options as bets
that the price of the underlying investment will go up
or down by a certain amount over a certain period of time.
You can buy futures contracts on agricultural or financial
products, natural resources, interest rates, and currency
values. You can buy options on stocks, stock and bond indexes,
interest rates, currency values, and futures contracts.
One appeal of derivatives is that you can use leverage,
or a small amount of your own money, to have control over
something of greater value. But derivative prices are volatile,
which means you can lose or make a good deal of money very
quickly if you use them in this way.
Because timing is critical, derivatives, especially futures,
are probably less well suited for buy-and-hold investors.
But for experienced investors who are comfortable making
day-to-day trading decisions, derivatives — and options
especially — may be a suitable way of adding variety
to an otherwise well-balanced portfolio. In fact, you can
use options conservatively to increase your income or limit
your risk from falling prices in your portfolio, or more
speculatively, for the leverage they provide.
Professor
Roger Ibbotson, Yale University, chairman and founder
of Ibbotson Associates
Professor
Roger Ibbotson, Yale University, chairman and founder
of Ibbotson Associates 