The Derivatives and Futures Market is the most potentially profitable market in the world. But it can be the most distructive one too!
Derivatives
A derivative is a financial term for a specific type of investment from which the price over a certain time is derived from the performance of the underlying asset such as commodities, shares or bonds, interest rates, exchange rates or indices like stock market index or consumer price index.
This performance can determine both the amount and the timing of the payoffs. The diverse range of potential underlying assets and payoff alternatives leads to a huge range of derivatives contracts available to be traded in the market. The main types of derivatives are Futures, Forwards, Options and Swaps.
Futures
A futures contract is a standardized contract, traded on a futures exchange
to buy or sell a certain underlying asset. at a certain date in the future, at a pre-set price.
The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. The futures price, normally, converges towards the settlement price on the delivery date.
A futures contract gives the holder the right and the obligation to buy or sell, which differs from an options contract, which gives the buyer the right, but not the obligation, and the option writer (seller) the obligation, but not the right.
In other words, the owner of an options contract can exercise (to buy or sell) on or prior to the pre-determined settlement/expiration date. Both parties of a "futures contract" must exercise the contract (buy or sell) on the settlement date.
To exit the commitment, the holder of a futures position has to sell his long position or buy back his short position
effectively closing out the futures position and its contract obligations.
Futures contracts, or simply futures, are exchange traded derivatives. The exchange acts as the counterparty on all contracts and sets margin requirement etc.
Forwards
A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. It is used to control and hedge risk.
One party agrees to buy, the other to sell, for a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collaterised, exchange of margin will take place according to a pre-agreed rule. Otherwise no asset of any kind actually changes hands, until the contract has matured.
The forward price of such a contract is commonly contrasted with the spot price which is the price at which the asset changes hands ( on the spot date, usually the next business day ). The difference between the spot and the forward price is the forward premium or forward discount.
Derivatives
A derivative is a financial term for a specific type of investment from which the price over a certain time is derived from the performance of the underlying asset such as commodities, shares or bonds, interest rates, exchange rates or indices like stock market index or consumer price index.
This performance can determine both the amount and the timing of the payoffs. The diverse range of potential underlying assets and payoff alternatives leads to a huge range of derivatives contracts available to be traded in the market. The main types of derivatives are Futures, Forwards, Options and Swaps.
Futures
A futures contract is a standardized contract, traded on a futures exchange
to buy or sell a certain underlying asset. at a certain date in the future, at a pre-set price.
The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. The futures price, normally, converges towards the settlement price on the delivery date.
A futures contract gives the holder the right and the obligation to buy or sell, which differs from an options contract, which gives the buyer the right, but not the obligation, and the option writer (seller) the obligation, but not the right.
In other words, the owner of an options contract can exercise (to buy or sell) on or prior to the pre-determined settlement/expiration date. Both parties of a "futures contract" must exercise the contract (buy or sell) on the settlement date.
To exit the commitment, the holder of a futures position has to sell his long position or buy back his short position
effectively closing out the futures position and its contract obligations.
Futures contracts, or simply futures, are exchange traded derivatives. The exchange acts as the counterparty on all contracts and sets margin requirement etc.
Forwards
A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. It is used to control and hedge risk.
One party agrees to buy, the other to sell, for a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collaterised, exchange of margin will take place according to a pre-agreed rule. Otherwise no asset of any kind actually changes hands, until the contract has matured.
The forward price of such a contract is commonly contrasted with the spot price which is the price at which the asset changes hands ( on the spot date, usually the next business day ). The difference between the spot and the forward price is the forward premium or forward discount.
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