Derivatives: introduction: overview
Trading in stocks and shares, commonly called ‘equities’, is typically undertaken on a stock exchange or a multilateral trading facility i.e. an equity marketplace. But buying and selling shares direct is risky and largely depends on the company that issued the shares performing well. If profits of the company are low, the amount of dividend paid out to shareholders will be equally low and this is reflected in the company market share value making it difficult to sell shares. Conversely, if company profits are low, it might make the shares more attractive to speculators who think the company’s fortunes will improve.
If the company fails, the shareholder may lose his investment as the shares will be worthless. Equally, if the company is performing well, again, this is reflected in a higher market price for its shares which, in turn, is less attractive to potential buyers.
A higher market share price will reflect the fact that investors want to hang on to successful stocks and shares.
Rather than individuals risking their savings by directly investing in shares of a company, or to guarantee a fixed share price for selling or buying shares, an individual may decide that a better alternative is investing in a derivative (see STSM111020).