Forex Trading And Systemic Risk: Toronto Attorney Guidance – Some derivatives, such as options and futures, are traded on an exchange, while others, such as CFDs and futures, are traded over the counter (OTC).

Warren Buffet, the famous investor, once called derivatives financial weapons of mass destruction. Interestingly, in 1982 he wrote to Congressman John Dingell discouraging Congress from endorsing the use of financial derivatives. Congress approved the derivatives and the rest is history.

Forex Trading And Systemic Risk: Toronto Attorney Guidance

Forex Trading And Systemic Risk: Toronto Attorney Guidance

This leads us to ask: Are derivatives harmful? Warren Buffet says there is nothing wrong with derivatives themselves, but says the problem is that they encourage leverage, which is borrowing funds from your broker to trade, similar to a funded trade.

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In addition, a derivative is essentially a financial contract that depends on the underlying asset for existence. It is always associated with wealth. Some derivatives, such as options and futures, are traded on an exchange, while others, such as CFDs and futures, are traded over the counter (OTC).

However, it should be noted that derivatives trading is associated with high risk. Incessant market volatility can lead to significant risk and uncertainty.

These risks and uncertainties have been fueled recently by interest rate hikes, the conflict in Ukraine, which many economic experts now fear could lead to a global recession or economic downturn.

Derivatives are ideal for hedging risk. When an asset is subject to high volatility, investors may choose to hedge the risk through futures or options trading. This is to reduce the risk that accompanies adverse price movements.

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First, when you enter into a futures contract with a counterparty, you have the right to buy from or sell to the other counterparty a certain amount of the underlying asset at a specific price and on an agreed date in the future.

At expiration, futures contracts can be settled in cash or through physical delivery of the underlying asset. Futures traders can opt for physical delivery of goods, while investors can choose to receive shares.

If you fear that TSLA stock will lose value in a month, you can enter a futures contract to guarantee that you will sell a certain amount of TSLA stock at today’s price in a month. By doing this, you have protected yourself from market risk.

Forex Trading And Systemic Risk: Toronto Attorney Guidance

Second, an options contract gives you the right, but not the obligation, to buy or sell a specific amount of the underlying asset at a specified strike price in the future. A contract that gives you the right to buy is a “call option” and the right to sell is a “put option.”

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To buy an option from an option maker, you pay them a “premium”. At the expiration of the option contract and due to the commitment clause, you can choose not to exercise the option and exit, but forgo the premium.

This lack of commitment is the main difference between options and futures. One option contract contains 100 shares of the underlying stock.

In 1982 In a letter to Congressman John Dingell, Warren Buffet warned that making derivatives trading easier would lead to people gambling and speculating instead of investing. We are seeing this today as many traders are now trading derivatives for the thrill and quick returns without considering the risk.

It is possible to lose all of your principal capital, and sometimes more, when trading options. The option premium has no fixed amount or price. However, three main factors can affect this, including the price of the underlying asset, its level of volatility and the option’s expiration date.

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Remember that options are traded on an exchange and their prices are determined by supply and demand. The closer the option expires, the lower the price will fall and the harder it will be for you to sell because you are a trader trading options for profit. This is the concept of option decay time. You refuse the premium and it is a loss for you.

Also, if you are a call option writer, you are exposed to a lot of risk. The writer of the call option, otherwise known as the guarantor, formulates the contract and sets a specific price and date.

The holder of the call option will be forced to sell the asset at the strike price to the option holder at expiration, even if the price rises above the strike price, meaning it is being sold at a significant loss.

Forex Trading And Systemic Risk: Toronto Attorney Guidance

This is because the holder of a call option takes a long position with limited downside risk, while the writer of a call option takes a short position with unlimited risk.

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The fortunes of the call writer and the option buyer move in the exact opposite direction. If the option buyer makes a profit, the call writer will make a loss and vice versa

Futures trading requires a higher level of skill due to the risks involved. Futures trading is more risky because the contract specifications are more complex than trading stocks or currencies.

As you can see from the table above, futures contract sizes are very important. Unlike CFD trading, where one CFD represents one unit of the underlying asset, you can see that one Chicago Wheat Futures contract is equivalent to 5,000 bushels.

For Chicago wheat futures, if the futures price moves from 4.0025 to 4.000, the difference is 0.0025, which is one tick under CME rules. This means you will lose (5,000 bushels x 0.0025) = $12.5

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Also, market valuation forces you to pay for any change in the price of the underlying asset. This payment is made daily, so if you decide to default or run, your broker will only be responsible for paying one day’s market movement. This can result in a security lien that can be liquidated if it is not taken into account.

Futures trading requires you to deposit initial margin and maintain a certain level of margin to maintain your position. If your margin is low, you may be closed out of the trading position.

In most cases, the maintenance margin is usually between 50 and 75%. Margin of maintenance is sometimes referred to as variation margin. Futures trading can be very dangerous because of the use of leverage, which multiplies your profits and losses.

Forex Trading And Systemic Risk: Toronto Attorney Guidance

A contract for difference (CFD) allows you to speculate and trade in both directions of price movement – up or down. CFDs allow you to take long (buy) or short (sell) positions without actually owning or accepting the underlying asset. However, this comes with a lot of risk, especially when you are short.

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If your speculation is wrong, you will have to pay the difference and pay it to the other party. Other risks associated with trading include low industry regulation, potential lack of liquidity and the need for adequate margin levels.

Also, CFDs are not exchange-traded derivatives, so you will be exposed to counterparty risk. In most cases, the CFD provider is your counterparty.

CFDs are widely used by day traders because they can close their positions before the end of the day without accruing fees and overnight interest. Traders register with day trading platforms that allow trading CFDs for a fee, but when the market is volatile, spreads widen and it can be difficult to find a counterparty willing to exit or close an open position.

As a result, most CFD day traders leave their positions open overnight, incurring the overnight fees they were trying to avoid. Many CFD traders also trade in illiquid assets, so liquidity also becomes an issue.

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CFDs are traded with leverage, like other financial derivatives, so every loss you incur is even greater, especially when you use excessive leverage, such as the unregulated jurisdictions offered by brokers in Africa and parts of Asia.

To put it bluntly, financial derivatives are very risky and can lead to loss of principal capital and further losses. Specifically, futures trading can be very dangerous. One movement of the tick can cause a huge loss of money. If you are wrong about your speculation, you are more likely to lose more than you invested.

You can get peace of mind if you invest instead of risking everything. Derivatives are the best hedging instruments and should be managed by professionals such as hedge fund managers and automated high-frequency trading firms.

Forex Trading And Systemic Risk: Toronto Attorney Guidance

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