Derivatives

RECENT NEWS
Mondo Visione  May 22  Comment 
The European Securities and Markets Authority (ESMA) has published an Opinion to the European Union (EU) institutions on the impact of EMIR on UCITS. In the opinion, ESMA calls for a modification of the UCITS Directive to take into account the...
Financial Times  May 20  Comment 
Harmonisation with US regulations expected by end of the year
The Economic Times  May 20  Comment 
It has been suggested to Sebi that the minimum lot size of an equity derivative contract could be increased to at least Rs 5 lakh.
Financial Times  May 19  Comment 
Trade in credit default swaps increases corporate bond liquidity
Mondo Visione  May 19  Comment 
Fundtech, now a part of D+H, is a market leader in global transaction banking solutions and today released a white paper on the reemerging relevance of embedded derivatives, and how this corporate accounting burden can be transformed into a...
Mondo Visione  May 18  Comment 
Effective 12 May 2015, the amended Moscow Exchange trading and admission rules will authorize cross trading on the Derivatives Market. The new rules require all cross transactions to be cleared through the CCP. The National Clearing Centre...
MedPage Today  May 17  Comment 
(MedPage Today) -- Nicotainamide reduces nonmelanoma lesions by a fourth in high-risk patients.
Mondo Visione  May 12  Comment 
As per p.2.5 of Principles of initial margin calculation (approved by NCC Clearing Bank Management Board on the April, 8th 2015) the quantity of settlement periods before the expiration date during which the expiration scenarios are taken into...
Reuters  May 11  Comment 
Chastened by several high-profile calamities in the recent past, many of the state companies China has freed to trade overseas derivatives will be sitting on their hands, put off by the risks or a lack of expertise.
The Hindu Business Line  May 10  Comment 
Yes, but with proper regulation, asserts this engaging book




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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