STSM111010 - Derivatives: introduction: overview

Trading in stocks and shares, commonly called ‘equities’, is typically undertaken on a stock exchange or a multilateral trading facility (MTF) i.e. an equity marketplace.

But buying and selling shares direct is risky and is largely dependent 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 will be reflected in the company’s market share value which could make the shares harder to sell. However, it might make the shares more attractive to speculators who think the company’s fortunes will improve.

If the company fails, shareholders may lose thier investment as the shares will be worthless. Conversely, if the company is performing well, this is reflected in a higher market price for its shares which, in turn, could be 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 perhaps 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).