Derivatives

RECENT NEWS
The Hindu Business Line  Oct 22  Comment 
India's securities regulator said stock brokers are allowed to take proprietary positions in currency derivatives as long as they do not exceed 15 per cent of total open interest or as long as it...
Mondo Visione  Oct 20  Comment 
Droit Financial Technologies, a leading provider of pre-trade front office and post-trade compliance solutions for derivatives, has appointed three well-known industry leaders to a new advisory board. Former CEO of ISDA, Robert Pickel, financial...
Mondo Visione  Oct 15  Comment 
The Derivatives Market"s interim clearing session is to end at 14:10 MSK on 15 October. This is due to additional verification of that market"s interim clearing results being conducted.
Mondo Visione  Oct 14  Comment 
Trading on Moscow Exchange's Derivatives Market was resumed at 3:30pm MSK after it was suspended from 2:14 pm MSK. Order cancellation became available at 3:15 MSK. Trading was suspended following detection of a malfunction in the market data...
New York Times  Oct 14  Comment 
Why did Wall Street support a change in derivatives contracts that limits its rights? It is in banks' interest to wind down a failing firm in an orderly way. But banks still benefit, even with the change.
Yahoo  Oct 11  Comment 
The $700 trillion financial derivatives industry has agreed to a fundamental rule change from January to help regulators to wind down failed banks without destabilising markets. The International Swaps and Derivatives Association (ISDA) and 18...
Mondo Visione  Oct 9  Comment 
TeraExchange announced today the first bitcoin derivative transaction to be executed on a regulated exchange. The initial trade was completed between digitalBTC, the world's first bitcoin-focused company to commence trading on a major stock...
New York Times  Oct 9  Comment 
One way to level the playing field is to simply repeal the safe harbors in the bankruptcy code, writes Stephen J. Lubben in the In Debt column.




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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