Derivatives as the term is not unknown to any of us whether we are traders or student.
In simple words 'Derivative' is some kind of contract which is derived from value of some underlying instrument or asset class based on its performance.
Derivatives are contract between 2 persons with or without middleman.
Most common derivative instruments are Future and Options. Whereas Forwards and Swaps are not known or used.
Lets have definition of these one by one.
Future is exchange traded contract and it includes 2 parties (excluding exchange - middleman) who have agreed to exchange ownership of underlying asset at certain date in future at specified price.
Option is contract between 2 parties who agree to buy or sell underlying asset without any obligation. In this case buyer of an option is required to pay some premium to seller (who in return get into obligation) and needs (seller) to sell his asset if buyer want to exercise his right. Options are both (Exchange traded as well as over the couter) Options are of 2 types - Call Option and Put Option.
Forward is contract between 2 parties (without exchange - middleman) who have agreed to exchange ownership of underlying asset at specified (fix date) at agreed price in future.
Swaps are contract between 2 parties who have agreed to exchange cash flows in future. These are not Exchange Traded Contracts.
In our next few posts we shall try to write more about these.
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