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Derivatives, The Future of Investing?

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CNN Money is featuring an article discussing derivative investments, in particular, investments designed for the small investor to hedge his or her bets. HedgeStreet is a company that lets people speculate on economic events, such as gas prices hitting $3.00 by a certain date. This hedge, for instance, might be good for someone with a long commute and would like to neutralize the effect of spending more on gas.

In order to invest in the derivatives offered by particular investment company, the investor needs only $100 to open an account, and any trades are limited to $10. The company calls these small items “hedgelets.” At HedgeStreet, the contracts available are based on economic events.

Regarding the gas price event hedgelet, I think it would make more sense to invest directly in oil companies rather than betting on economic events. It seems that oil profits will rise as gas prices go up, but there may be a larger chance of missing any specific price target, in which case the investor would lose all money invested.

If you believe the people who sell these investments, derivatives are poised for growth among regular investors. Others warn that most people who trade don’t understand the drivers of economic events, and those who don’t shouldn’t place bets. Trading online makes it easier for the uninformed to participate. “… Investors who trade online may mistake readily available information on the Internet for knowledge, which can fuel overconfidence and speculation.”

Updated March 12, 2011 and originally published August 25, 2005. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 2 comments }

avatar Jeff

This site, if used, shouldn’t be used to “bet” on whether gas prices will rise, or if the price of energy will fall. Investing in the derivatives market is hugely complicated, and most futures contracts are reasonably efficiently priced, meaning there is no arbitrage opportunity for the regular investor.

Investment banks have been doing this for years, but it is for the following reason: If an investment bank prices a complicated product at $9, they may sell it for $10. Since they don’t want to actually make the investment themselves, they will hedge their $9 worth of exposure and pocket the $1 difference. A consumer at this site pays a premium for the contract, which by definition will be more expensive than it is actually worth (the company needs to make money). Thus their expected return is negative over time. Sure it’s exciting to bet whether gas will jump over $3.00 a gallon, but if the price of the bet outweighs the expected payoff, it’s obviously not a good bet to make.

Jeff
http://www.roadtorich.com

avatar Luke Landes ♦127,435 (Platinum)

Jeff,

Thanks for the good look from the investment company’s point of view.

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