derivatives

• Derivatives


  A financial contract whose value is dependent on an underlying set of group of asset
• Commonly used assets


  • Stocks
  • Bonds
  • Currencies
  • Commodities
  • Market indices
• The value of the underlying asset keeps changing according to market condition
• Basic principle behind entering into derivative contracts


  To earn profits by speculating on the value of the underlying asset in future
• If the market price of the wheat rises to rupees 2020, the farmer ends up losing rupees 20 per quintile as he is bound to sell at rupees 2000
• Four major types of derivative contracts

  • Forwards
  • Futures
  • Options
  • Swaps
• Forwards and Futures


  Financial contracts that obligate the buyer to purchase an asset at a pre agreed price on a specified future date
• Difference between Forwards and Futures

  Futures are traded on exchanges while forwards are customized contracts and they are not traded anywhere
• Options


  Provide the buyer of the contracts the right but not the obligation to purchase or sell the underlying asset at a predetermined price
• Types of Options


  • Call option
  • Put option
• Call option


  You have the right but not the obligation to buy a given quantity of underlying asset at a given price
• Put option


  You have a right but not the obligation to sell a given quantity of the underlying commodity or asset at a given price
• Swaps


  Derivative contracts that allow the exchange of cash flows between two parties
• Popular types of Swaps

  • Interest rate swaps
  • Commodity swaps
  • Currency swaps
• Mark-to-market


  Recording the price or value of the security to reflect the current market value rather than the book value
• Benefits of Derivative Trading

  • Hedging risk exposure
  • Underlying asset price determination
  • Higher returns
• Risks of Derivative Trading

  • High volatility
  • Peculiar features
• Derivatives trading can be extremely beneficial but it is suggested to enter only after having 6 years of experience in the stock market