In this part of my series on understanding the stock market we are going to be learning about stock derivatives.
Derivatives are a number of stock like products in which people speculate and invest.
While not exactly like stock they are directly based on them and are traded on exchanges.
These derivatives require far more expertise and are far more volatile than regular stocks.
For this reason they are best avoided by new investors.
Here are the various kinds of derivatives.
· Subscription rights · Warrants · Options · Calls · Puts Here is an explanation of each kind of derivative · Subscription rights - these are formalized promises from a company to sell its stock to its current holders at a price reduced from the market price in the event of a new stock being issued.
Investors make money from subscription rights by selling them to people who want to buy the shares at the reduced price.
· Warrants - these are similar to subscription rights in that they allow you to purchase stock at reduced prices.
They differ from subscription rights in that subscription rights entitle you to deduct a certain amount from the price of the stock while warrants entitle you to purchase stock at a predetermined price, regardless of the current price the stock is selling for on the market.
· Options - options allow give the holder the right to purchase or sell shares at a predetermined price.
An option that entitles you to buy a stock is known as a call, while an option that allows you to sell the stock is a put.
The predetermined price it is sold or bought at is the strike price.
· Calls - by purchasing a call option you are entering into an agreement with the seller to purchase a stock at a predetermined price, regardless of the stocks actual market value.
· Puts - put options are the opposite of calls in that they give the holder the right to sell at a predetermined price.
Note that the holder of a put has the right not the obligation to sell those shares.