A Look at Derivatives and Precious Metals

Jonas Elmerraji

There's a world of investing outside of stocks and bonds . And that world can be quite a lucrative one -- so much so that some investors completely eschew the more traditional investments that we've grown accustomed to (see "Allocate Your Assets Like a Pro"). So, what exactly do "nontraditional" investments like derivatives and precious metals have to offer you?

Derivatives

While often talked about in the financial world, derivatives are probably unfamiliar to most investors. Essentially, a derivative is any financial instrument that gets its value from another financial instrument. A couple of the more prevalent types of derivatives out there are options and futures.

Stock options give their owners the right to engage in a stock transaction at a predetermined price. For example, if you have an option to buy a share of Google(GOOG) at $100 (a call option ), the value of the option is derived from the value of Google's stock. If Google's share price increases, the value of that option increases, because you're getting a more valuable share of stock for that $100. Conversely, if Google's share price drops, so does the value of your stock option.

Futures can be similar to stock options, except they generally involve commodities like crude oil, gold and sugar (futures can actually be less accessible to individual investors than stock options).

While options and futures get the most attention, there are other kinds of derivatives out there too. Derivatives can be based on anything from stocks and commodities to interest rates, currencies and even the weather. Some derivatives are even based off of other derivatives.

Derivatives can trade on a lot of different exchanges , from traditional markets like the American Stock Exchange (AMEX ) to special exchanges designed specifically for a particular type of derivative like the Chicago Board Options Exchange (CBOE ). Many derivatives also trade over-the-counter (OTC ).

Why Would You Use Derivatives?

One of the simplest uses for derivatives is to hedge (or limit the risk in) the investments you currently hold (see "Finance Professor: Five Hedging Techniques You Must Know"). If you are short a stock, an option to buy that same stock at a low price could protect you from serious losses if its share price increases.

Hedging through derivatives is often used by huge companies on a very large scale. You wouldn't necessarily expect to find traders working at an airline, would you? JetBlue(JBLU) has benefited immensely from its use of oil futures to hedge against recent unfavorable prices of one of its biggest expenses, jet fuel. Many industries wouldn't survive without derivatives as a hedging tool.

Derivatives are also used by more seasoned investors as speculative investments. One of the benefits of trading derivatives is the fact that you don't necessarily need to deal with taking physical possession of 10 barrels of crude oil or deal with the banking conundrum that presents itself when you've just bought 20 million Yen (Japanese currency ) because your futures hit their settlement date . And while the upside to speculating with derivatives can be fantastic, dealing with this kind of investment can be complex enough that it should probably be avoided by all but those who know what they're doing.

To learn more about options and futures, check out these resources on TheStreet.com:

• "Options: Getting Started"
• "Getting Started With Futures"
• The Latest Options and Futures Stories
• TheStreet.com TV's Options Report Channel
• TheStreet.com Options Alerts

Precious Metals

Man has always had a fascination with precious metals; they're rare and they're shiny -- what more could you want in an investment?

Precious metals are categorized as commodities, along with basic goods like coffee, orange juice, crude oil and steel. Today, they remain a popular investment (and a source of heated argument for many investors).

We're all pretty familiar with a few of the precious metals -- silver, gold and platinum all grace our credit cards, after all. But other metals like iridium and palladium are also very valuable and are bought and sold by investors hoping to hold on to their values.

From an investment standpoint, precious metals trade on the commodities exchanges (and yes, there are precious metal-based derivatives too). But many people invest in precious metals in the form of jewelry or rare coinage. Exchange-based metal investments tend to be much more liquid than their counterparts.

Are Precious Metals a Worthwhile Investment?

There is often debate as to whether or not precious metals actually constitute a good investment. The bottom line is this: While precious metals have not historically appreciated as quickly as an investment in the stock market, they do offer a good deal of stability to your net worth .

In the long term, precious metals have proven themselves to hold their value (and by long term, I do mean long term -- we've been after silver and gold for thousands of years). So, if you're looking for steady appreciation over the long term, precious metals might just be a golden investment for you.

To learn more about precious metals (for example, the advantages and disadvantages of owning metals instead of the mining stocks), check out these resources on TheStreet.com:

• "Ask TheStreet: Precious Metal"
• "Ask TheStreet: Glittering Gold"
• "Street Smarts: What Is the Gold Standard?" (video)
• "How to Play the Commodities Markets"
• The Latest Commodities (and Energy) Stories

Even if you're new to the investing arena, the worlds of derivatives and precious metals might be worth looking into. Each is very different from the world of stocks and bonds, but either one of these nontraditional investments could be your golden ticket to a great return .

Homework Time

Here's an assignment for each investment that could help you get sure footing before you put your money on the line.

1. Dig In to Derivatives: Check out All About Derivatives by Michael Durbin. It's a readable, in-depth primer on trading derivatives that doesn't cost as much as a college textbook.

2. Paper Trade Precious Metals: If you're interested in trading precious metals, you're going to have to familiarize yourself with technical analysis and that means charts (see the "Chart of the Day" Column). "The Basics of Technical Analysis" on TheStreet.com is a good start. Then, when you're ready, do some "paper trading" to see if you're on the right track.

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