Four ways derivatives can help you manage risk.

1 Suppose your portfolio has become too heavily weighted in the equities area and you'd like to pull back a little. But you're generally pleased with your portfolio manager's performance and don't want to undercut his efforts. How do you get back on target without upsetting the whole structure?

SOLUTION: An allocation swap fits the bill. Here's how it works:

* You enter into a swap with a swap counterparty, using the equities it wants to allocate to a different asset class.

* You pay the S&P 500 total return (appreciation and dividends) to the counterparty.

* In return, you get a fixed-income or other asset-class return, plus or minus the spread from the counterparty.

BENEFITS

* Simple way to achieve asset-allocation goals without disturbing existing fund management.

* Allows flexibility in fine-tuning allocations without being constrained by manager's actions.

RISKS

* Credit risk of swap counterparty

This scenario is a straightforward allocation swap, a transaction with many applications. Here, an active manager has done well in one area but has thrown the allocation off for the short-term. The allocation swap allows you to readjust by bringing those allocations back into line. As the example demonstrates, the plus or minus on the spread will be a function of the Standard & Poor's total return when the transaction is priced. Don't feel constrained by what an asset manager is doing, nor should you think you're incapable of reallocating. A swap is a simple, straightforward way to retain the active manager's outperformance of the S&P.

You might wonder whether the active manager now has a negative output in the ongoing time period and whether you've potentially added more risk to the portfolio. In fact, you haven't changed what the portfolio manager is doing. What you've done is take some basis risk between the type of portfolio that he or she runs and the index return you're paying away. Suppose the portfolio manager is trying to replicate the S&P plus 100 basis points. When he or she hits that level, you haven't changed those 100 basis points. You're going to earn the S&P plus the 100 basis points and pay only the S&P. The other asset class that you get will retain that 100 basis points generated for you.

This example presumes that you like the manager's performance and style, so instead of taking the money away from the individual, you use the swap. However, if your manager doesn't perform well, you've got a risk whether or not you use derivatives. In other words, derivatives don't change the basic risks in your portfolio -- they just help you manage them differently.

2 What if you've got the opposite situation? You want to outperform certain investing benchmarks like the S&P 500 index, but your manager has flubbed the job or has turned in an uneven performance. Can derivatives help you correct the problem?

SOLUTION: Use a longer-term derivative instrument, such as a...