Question

what are the main Risks associated with Trading Derivatives ?

Answer 1

Answer- There are mainly 3 Risks related with trading in derivatives.

1. LIQUIDITY RISK

Liquidity risk applies to investors who plan to close out a derivative trade prior to maturity. Overall, liquidity risk refers to the ability of a company to pay off debts without big losses to its business. To measure liquidity risk, investors compare short-term liabilities and the company's liquid assets.Firms that have low liquidity risk are able to quickly turn their investments into cash to prevent a loss . Such investors need to consider if it is difficult to close out the trade or if existing bid-ask spreads are so large as to represent a significant cost.

2. COUNTERPARTY RISK

Counterparty risk, or counterparty credit risk, arises if one of the parties involved in a derivatives trade, such as the buyer, seller or dealer, defaults on the contract. This risk is higher in over-the-counter, or OTC, markets, which are much less regulated than ordinary trading exchanges.

3. MARKET RISK

Market risk refers to the general risk of any investment. Investors make decisions and take positions based on assumptions, technical analysis, or other factors that lead them to certain conclusions about how an investment is likely to perform. While there is not a surefire way to protect against market risk, as all are vulnerable to changes in the market, knowing how much a derivative is impacted by market fluctuations will help investors choose wisely