by Adam Shaw Working Lunch's markets expert

A number of Working Lunch viewers have written to me about hedge funds.

So what is a hedge fund?

Unlike other investment funds it doesn't invest directly in shares but buys derivatives.

These are options to buy and sell. By doing that they can profit even from a falling market and can make a profit even in difficult circumstances.

However, they manage to make these sorts of returns by taking big risks. And while they can make money by taking big risks, they can also lose a lot.

For example...

If you think Marks & Spencer shares are going to fall you can still make money from them by buying an option to sell.

That allows you to sell the shares in the future but at a price you have fixed today. It's like getting a guarantee that you can sell your car in a years time for an agreed profit.

A hedge fund might spend 20 pence to buy an option which allows it to sell Marks & Spencer shares at 360 pence.

If the shares fell to �2 the hedge fund would buy them at �2 and then exercise its option to sell them at 360 pence. Making a profit of 63% even while prices are falling.

Worthless

However, if prices rose to �5 the sell option would become worthless because you wouldn't want to sell the shares for 360 pence when you could get �5.

Therefore you have lost all the money you spent on the option and your profit and asset have been wiped out.

Investment expert David Hanratty says hedge funds are incredibly risky: "They should be part of a portfolio, maybe 5%, but one of the problems investors have got is that the minimum investment is about �25 000".

No second places

We say that the stock market is a gamble but even when a share price falls at least you still own the share. You still have something.

A hedge fund is really like a bet on the horses - if you win, you can win big. But there are no second places here. If you lose, you can lose everything.