Derivatives

RECENT NEWS
Financial Times  Jul 3  Comment 
Prospects for interest rate rises in the US and UK brought isolated bursts of activity to an otherwise slack first half of the year on the world’s largest derivatives exchanges
The Hindu Business Line  Jun 30  Comment 
Trading can resume once Govnt amends the Forward Contracts (Regulation) Act
Mondo Visione  Jun 26  Comment 
Singapore Exchange (SGX) announced today that Hong Kong-based Emperor Futures Limited has joined its derivatives market as a Trading Member. “We are pleased to welcome Emperor Futures as Trading Member to our derivatives market. The active...
New York Times  Jun 25  Comment 
The rule, stemming from the Dodd-Frank law, identifies which subsidiaries need to register with the Securities and Exchange Commission and fall under more stringent trading standards.
Reuters  Jun 25  Comment 
The BSE Sensex and Nifty fell on Wednesday for a fifth session in six, with blue-chips such as Reliance Industries Ltd taking a hit as caution ahead of expiry of June derivatives on Thursday and fears of more violence in Iraq prompted investors to...
Mondo Visione  Jun 23  Comment 
Singapore Exchange (SGX) today welcomed SinoPac Securities (Asia) Limited to its derivatives market as a Trading Member. Chew Sutat, Head of Sales and Clients at SGX, said: “We are pleased that SinoPac Securities (Asia) is joining our...
Wall Street Journal  Jun 18  Comment 
Eight Taiwanese banks will pay a total of nearly $1 million fines to the Financial Supervisory Commission for misleading clients into overinvesting in complex derivatives that bet on the Chinese yuan.
MarketWatch  Jun 12  Comment 
English transplant Jonathan Clegg laments American soccer fans’ wholesale import of European football’s various trappings.




RELATED WIKI ARTICLES
 

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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