Derivatives are instruments that derive their value from an underlying asset. The most common types of derivatives are futures, options, and swaps. Equities, on the other hand, are ownership stakes in a company. The two main types of equities are common stock and preferred stock.
4 differences between derivatives and equities
Now that we’ve covered the basics, let’s look at some of the more important distinctions between these two kinds of investments.
Derivatives are contracts, not ownership stakes
The first and most crucial difference to understand is that derivatives are contracts, not ownership stakes. You’re not buying anything physical or tangible when you buy a derivative, and you agree to buy or sell an asset at a specific price on a future date.
One of the most critical features of derivatives is that they allow you to gamble on the price of an asset without actually possessing it. Assume you believe the price of gold will rise, and you could establish a futures contract that gives you the right to purchase gold at a specific price later. If the value of gold rises, you may buy it for less money and profit from its subsequent rise.
Derivatives are also used for hedging purposes. For example, let’s say you’re a farmer who is worried about the price of corn going down before you harvest your crop. You could buy a corn futures contract and agree to sell your corn at a set price on a future date. Even if corn does go down, you’re still guaranteed to get a specific price for your crop.
Equities are ownership stakes in companies
The second key difference to understand is that equities represent ownership stakes in companies, and this means that you’re buying a piece of a company when you buy equity.
Two main types of equities
Common stock is the most common type of equity, and it represents ownership in a company. Preferred stock is a less common type of equity, and it typically pays fixed dividends.
One of the key benefits of owning equities is that you have the potential to earn a return through both dividends and capital gains. Dividends are periodic payments that companies make to their shareholders.
Another benefit of owning equities is that you have voting rights, and you can have a say in how the company is run. For example, you can vote for the board of directors and participate in other important decisions.
Derivatives are more complex than equities
The third key difference to understand is that derivatives are more complex than equities. There are many different types of derivatives, and you can use them for various purposes.
Because of their complexity, derivatives can be hazardous investments. If you don’t know what you’re doing, you could lose a lot of money quickly. For this reason, it’s essential to understand all of the risks before investing in any derivative.
Equities are less complex than derivatives
The fourth and final key difference is that equities are less complex than derivatives. There are only two types of equities: common stock and preferred stock. And, unlike derivatives, there’s no need to worry about expiration dates or exercise prices.
However, even though equities are less complex than derivatives, they’re still risky investments. A stock’s price may rise or fall, and if you invest in a firm that goes bankrupt, you might lose money. As a result, it is critical to fully comprehend the hazards before fully putting money into any equity.
The bottom line
If you’re looking for a more complex investment with the potential for higher rewards, then derivatives might be a good choice. However, if you’re looking for a less complex investment that’s less risky, then equities might be a better choice.