Derivative securities play an essential role in the stock market, and are often cited as impacting the current economic crisis. There are two primary types of stock derivatives that an investor may choose to purchase: exchange traded derivatives and over the counter (OTC) derivatives. There are benefits and disadvantages associated with each of these types of securities.
Exchange traded derivatives are derivatives traded on an organized, regulated exchange. Essentially, over the counter derivatives function in the same manner as exchange traded derivatives, only they are dealt between individual parties as part of private arrangements. In many cases, exchange traded derivatives will require a greater deal of collateral than over the counter derivatives.
Therefore, an investor may find it beneficial to purchase an OTC derivative as opposed to an exchange traded derivative. Besides, purchasing a derivative often provides a stockholder with the security of obtaining a specified number of shares for a set price. Therefore, if the price of stocks increases, an individual that purchased a derivative security will be permitted to obtain stocks at a lower price.
However, it is important for an investor to understand some of the problems that are often associated with these types of securities. An investor must be cautious when purchasing derivative securities, especially if they are seeking to attain over the counter derivatives, as some issuers try to take advantage of the inexperience of new investors. Therefore, an investor may pay more than necessary for a derivative security.
