Most of the publicly traded investments in the world are made up of stocks and bonds. However, there have always been “alternatives”. There are some real estate investment trusts that give you a stake in actual real estate, but for the most part publicly traded REITs are investments in companies that own said real estate – making them a stock. Precious metals are a good example of an alternative investment. There was a time when the New York Stock Exchange had a “gold room” where investors could trade; and the first gold ETF was created in 2003. Other commodities that are not popular with individual investors are also considered alternatives – beef, cotton, lumber to name a few. These types of commodities actually gave birth to the fastest growing alternative investment today – Derivatives.
In the investment world, a Derivative is a contract between two parties. Imagine being a farmer. You need to sell your crops or livestock to someone, and you would like that price to be as high as possible. If for some reason you thought the market price would be lower in the future you may want to negotiate a price with your buyer now, before the goods are available. Likewise, if you are a buyer and think that prices will be higher in the future you may want to lock in a lower price now. These negotiated prices for delivery of an asset in the future are known as forward contracts and are the foundation of all derivatives.
Options contracts work in a similar way with the underlying asset usually being a publicly traded stock. Options based investment strategies have gained a lot of attention recently and rightfully so, in my opinion. The problem with options of course is the risk. They can be very confusing and because the price of the contract is based on the price of the underlying asset, you not only have to deal with traditional equity risks but also the specific risks associated with the option itself.
Since the start of the 21st century we have seen slow but steady increase in the amount of money being invested in the alternative space. How much more can go in, is a great question and hard to answer. But there was a time, not too long ago, when retail investors would have gasped at the idea of investing in a stock rather than a bond because of the risk. I suspect that as time passes on, investors will get more and more comfortable with the risks associated with some alternatives.
* Options are not suitable for all investors. Typically, commissions are charged for options transactions. Transaction costs may be significant in multi-leg option strategies, including collars, as they involve multiple commission charges. Please contact your financial advisor for a copy of the Options Disclosure Document (ODD).