The main difference between derivatives and equity is in how their value is derived, and the reason why they are traded. Equity derives its value on market conditions such as supply and demand along with news related to the company, economy or other events. In contrast, the value of derivatives is affected by other financial instruments such as bonds, currencies, commodities, and equity such as shares. The main purpose of investing in equity is to make a profit while derivatives can be used as part of a hedging strategy to mitigate risk.
Investing in derivatives can be rewarding but like every financial decision, the parties involved should be aware of any associated risks. Most importantly, an investor must understand the purpose of trading derivatives. They can be included as part of a portfolio diversification strategy or to speculate on the price of a financial instrument. Analysis of the value of the underlying asset should be conducted, including its price movement and any economic news that may affect it.
Derivative trading can be profitable but it depends on the purposes of trading. With respect to arbitrage, traders look to extract a profit by exploiting tiny differences in the pricing of identical assets in two or more markets. In contrast, if derivatives are being used for hedging purposes, the aim is not to gain a profit. Instead, it is to offset a similar gain or safeguard against potential future price fluctuations.