Derivatives

RECENT NEWS
The Economic Times  Mar 25  Comment 
Market regulator Sebi has barred the country's second most-valued firm as well as 12 other entities from equity derivatives trading for one year.
The Economic Times  Mar 23  Comment 
Experts are taking a cue from the rise in the ratio of stocks traded in the derivative market versus the index to gauge the quantum of leveraged positions.
The Economic Times  Mar 20  Comment 
A put option is purchased when a trader expects an underlier - in this case the dollar - to fall.
Financial Times  Mar 15  Comment 
Giancarlo seeks to review CFTC’s regulations and reform market surveillance 
Financial Times  Mar 15  Comment 
Traders in key grains region have a new hedging and investment tool
Mondo Visione  Mar 13  Comment 
CloudMargin, the multi-award winning creator of the world's first web-based collateral and margin management solution, today announced that Nasdaq Clearing has been included into the CloudMargin platform. This will provide Nasdaq Clearing's...
Flightglobal  Mar 7  Comment 
The latest derivatives of two new airliner types broke cover today at roll-out ceremonies in North and South America.
The Hindu Business Line  Mar 5  Comment 
This will curb manipulation of prices and help bring down volatility
Mondo Visione  Feb 27  Comment 
Trax®, a leading provider of regulatory reporting, trade matching and capital market data services, has reached agreement with Droit Financial Technologies (“Droit”), the provider of real-time global regulatory decision systems for...




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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