Derivative Products
Let’s learn more about derivative products. There are a number of products and instruments that fall under the category of derivatives. Individuals enter these contracts based on their preference of agreements, time lines, risk management and pricing. Commonly used derivatives are
- Forwards: A forward contract is an agreement between two parties to buy or sell the underlying asset at a future date, at the current date’s pre-agreed price.
- Futures: A futures contract is an agreement between two parties to buy or sell the underlying asset at a future date at today’s future price. Futures contracts differ from forward contracts in the sense that they are standardized regulated and traded on the exchange.
- Options: There are two types of options – call and put. A Call option gives the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. A Put option gives the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.
- Warrants: Options generally have a validity of up to a year. Usually, options are traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter (OTC).
- Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a weighted average of a basket of assets. One form of basket options is the Equity Index.
- Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be considered as portfolios of forwarding contracts. The two commonly used swaps are:
- Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
Interest rate swaps: These involve swapping only the interest related cash flows between the parties in the same currency.
