Derivatives

RECENT NEWS
newratings.com  Aug 26  Comment 
PALO ALTO (dpa-AFX) - A U.S. District Judge has on Monday slammed technology giant Hewlett-Packard Co.'s (HPQ) settlement reached in late June with attorneys representing its shareholders in derivative lawsuits related to its troubled $11.1...
Reuters  Aug 22  Comment 
Reuters Market Eye - United Spirits falls 3.2 percent after NSE excludes the stock from the derivatives segment.
Mondo Visione  Aug 21  Comment 
ISDA member firms participating in the industry-led WGMR implementation initiative are concerned about the market’s ability to meet an implementation date of December 2015. This concern is based not only on the significant infrastructural...
Mondo Visione  Aug 21  Comment 
The International Swaps and Derivatives Association, Inc. (ISDA) today announced the launch of the ISDA 2014 Credit Derivatives Definitions Protocol.   The Protocol is part of the implementation process for the 2014 ISDA Credit Derivatives...
Mondo Visione  Aug 21  Comment 
Following the call for interest for the renewal of the Consulative Working Group for the Commodity Derivatives Task Force, ESMA today announces the composition of the new group. 
The Economic Times  Aug 20  Comment 
Overseas investors bought equity derivatives worth Rs 4,122 cr on Tuesday, NSE data showed. The amount included Rs 2,853 cr worth of index options.
Financial Times  Aug 19  Comment 
Renewed boom in credit derivatives being powered by yield-hungry investors and could prove enormously costly once market volatility erupts
New York Times  Aug 15  Comment 
Regulators are pushing for changes that will affect derivatives. | G.E. is in talks to sell its appliances unit. | Coca-Cola announced that it had acquired a stake in Monster Beverage. | Bitcoin's pop may exceed its potential.
New York Times  Aug 15  Comment 
While Wall Street is largely resigned to the regulators’ ultimately getting their way, it is nevertheless pressing for measures seen as protections in return.




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Derivatives are investment vehicles whose price is dependent on an underlying asset. The most common form of derivatives include stock options, futures & swaps. Options are contracts that give the holder the right but not the obligation to buy or sell a specific security at a pre-determined price on a pre-determined date. The two kinds of options are call and put options. A call holder has the right but not the obligation to “call” stock away from the call writer. So as the price of the underlying security, in this case a stock moves up (or down) the call option becomes worth more (or less). Since derivatives are essentially a contract with an associated value there are many forms of derivatives. Some companies use derivatives to hedge against natural resource price swings or fluctuations in weather that may affect yields.

Derivatives are used by investors to:

  • Provide leverage (or gearing), such that a small movement in the underlying value can cause a large difference in the value of the derivative
  • Speculate and make a profit if the value of the underlying asset moves the way they expect (e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level)
  • Hedge or mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out
  • Obtain exposure to the underlying where it is not possible to trade in the underlying (e.g., weather derivatives)
  • create option ability where the value of the derivative is linked to a specific condition or event (e.g. the underlying reaching a specific price level)


Example: A lease option to buy a house. The lease contract has terms that give you the right to buy the house at a specific price any time you want (until the lease contract expires). Suppose the terms stated that you could buy the house anytime within the first year of leasing from the owner for 100,000. If the price of the house (local real estate boom) increased to 150,000 you could buy the house for 100,000 and then sell it for 150,000 for a profit of 50,000. If the price of house price dropped (perhaps crime increase) you would have no incentive to exercise your option to buy, so you let that contract expire (worthless) and you do not buy the house. As illustrated here, the contract derives its value NOT from the paper on which it is written, but from the actual market price of another object (the house in this case). This is the basic premise for instruments of specualation known as derivatives.

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