In message , The Natural Philosopher
writes

Can someone kindly give me an explanation of derivatives? Preferably
in plain English:-)
I think I have grasped the principle of *short selling* and stock
lending.


First of all, forget the calculus meaning.


A derivative product is one that does not involve buying or selling the
underlying share, biond, currency etc. but a product DERIVED from it.

If you like, buting a race horse and winning a race with it, is the
normal stock market.

Placing a bet on the horse is a derivative.

So is insuring it, in fact.

Derivatives are contracts of a sort, which have value depending on the
underlying value of some actual tradeable element.


Things get confusing when you but shares in e.g. funds that trade in
derivatives..


There's an interesting bit of recursion if a company invests its funds
in derivatives of its own share price.

And in fact, to an extent, a lot of derivatives are in fact of that
sort. So there is massive potential for positive feedback.

This is why they are regarded as leading to excessive volatility -
(think high gain: they amplify small perturbations).


The essence of rogue trading, is that a large financial institution
that takes a bet on an underlying, is supposed to lay that bet off by
buying or selling the underlying, or at least selling bets the other way.

If a trader doesn't do that, he becomes a punter or a bookie with high
exposure.

Hmm.. Thanks.

I suppose horse racing bets are an accepted fact of life.

Would the world shudder to a halt if derivative trading was regulated?

regards

--
Tim Lamb