Derivatives

Derivatives are the securities that derive a value from an underlying asset or a benchmark

It is not a primary product, it is a secondary product based on primary product; Here primary products are
benchmark, stock or interest rate.

It is mainly used to Hedge a portfolio

Common derivative includes future contracts, forwards, options &swaps

Forward Contract
A forward contract is a customized contract between two parties to buy or sell an asset at an specified price on a
future date.

It is not trading in exchange

Ex: There are two parties “A” & “B”. “A” & “B” enters into contract by “A” telling from next 3 month onwards
he is gonna buy the stocks at $100 irrespective of market price.

Here the main problem is counterparty risk.

Futures Contract
A futures contract is a legal agreement to buy or sell a particular commodity, asset or security at a
predetermined time at a specific time in the future.

It is trading in exchange

There is no problem of defaulter risk

The main difference of forward & future contract are: in forward contract if one party cancels a contract the
other party can’t do anything because it is not traded in exchange .

Options
An options contract is a agreement between two parties to facilitate a potential transaction on the underlying
securities at a present price, referred to as a strike price, prior to the expiration date.

The option is not exercised

Call option
Call option are the financial option that give the buyer option the right to buy an underlying asset

Put option
PUT option are the financial option that give the buyer option the right to sell an underlying asset

There are three categories in option:

ATM
At the money(ATM) are calls & puts whose strike price is at very near to the current market price of the
underlying security

ITM
In the money(ITM) is if the market price is above strike price

OTM
Out of the money(OTM) is it does not have intrinsic value; it has only extrinsic value.