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.