| July 03
Types of Derivatives and Derivative Market
Another name for the financial
markets is volatility. To curb the losses due to this characteristic,
derivative products were introduced in the history of financial markets. Such
instruments do not have their prices but derive their prices from the
underlying assets like stocks, bonds, interest rates. The primary objective of
the derivative is to minimize risk and provide a sense of certainty to the
investor’s portfolio. However, a major chunk of transaction volume is that of
the speculative derivatives trading.
Types of Derivative:
The variety of derivatives products
available in the market is surprisingly high. Investors can easily pick one
that suits their investment criteria. However, they all trace back to the basic
four categories that are as follows:
1. Forward Contract:
Such contracts deals with an agreement between the two parties to buy or sell
the underlying at the predefined prices in the future date. They are traded
over the counter and are easily customizable.
2. Future Contract:
These are similar to a forward contract in terms of the underlying mechanism
and different otherwise. Unlike forward, futures contracts are standardized
contracts traded on an exchange. Also, there is no counterparty risk involved
in this deal with the daily settlement of gains and losses.
3. Option Contracts:
In this type, there are two parties involved in buying and selling of this
contract. The buyer of the option has the right but not the obligation to buy
or sell the underlying. Whereas, the seller is obligated to buy or sell the
underlying. There are two types of options contracts- call and put. The call
options provide you the right or obligation to buy the stock. Whereas the put
option provides you the right or obligation to sell the stock.
4. Swaps: In this, the
parties involved are enabled to exchange their stream of cashflows. As an
example, a fixed interest rate can be swapped for the floating one.