Commodities whose value is derived from the price of some other assets like security currency interest level stock market index or anything else are known as Derivative It is a generic term for a variety of financial instruments. Essentially, this means you buy a promise to convey ownership of the asset, rather than the asset itself. The legal terms of a contract are much more varied and flexible than the terms of property ownership. In fact, it’s this flexibility that appeals to investors. .

When a person invests in derivative, the underlying asset is usually a commodity, bond, stock, or currency. He bet that the value derived from the underlying asset will increase or decrease by a certain amount within a certain fixed period of time

A contract that specifies the rights and obligations between two parties to receive or deliver future cash flows (or exchange of other securities or assets) based on some future event.
For example: the right (but not obligation) to buy 100 barrels of oil at $80 per barrel in 2 years time is a call option.

Commodity of derivative
option – right without obligation to exercise
the contract contract

future – right with obligation to exercise the

 When a investor with the help of a future
forward contract , he basically locked himself at a price with no room of taking the advantage of the favorable price moment of the asset in the cash market as both the buyers and the sellers have the obligation to honor the contract

Option address this issue of advantage to the hedger in case of favorable price movement in the price of the underlying, by offering the right to buy or sell the underlying . Therefore the essential difference between future and option contract is that in future contract both the parties has obligation to perform the contract , while in case of options , only the seller has the obligation while the buyer has the right without the obligation to exercise the contract In order to acquire the right of option , the option buyer pays to the option seller an option premium which is the price pays for right

Types of option
 Call option :- the option which gives the
buyer a right to buy the underlying asset is called a call option  Put option :- the option which gives the buyer a right to sell the underlying asset is called a put option

Simple Binomial Model used for Pricing Call Option
Current share price = 100 today Suppose next day price will be 115 or 95 but we do not know probability Pre-agreed exercise price of the call option is 100

Suppose share price increase to 115 or decrease to 95 suppose we buy 0.75 shares to hedge the call sold option portfolio valuation next day if share price rises = 0.75(115)-15=71.25 if share price falls = 0.75(95) - 0 = 71.25

Style of option
 American option :- an option that is
exercisable on or before the expiry date is called American option  European option :- an option that is exercisable only on expiry date, is called European option

 Futures Contract means a legally binding
agreement to buy or sell the underlying security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a prespecified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash.

DERIVATIVE MARKET The financial market for derivatives is known as the derivative market. The derivative market has two parts:
 Exchange Traded Derivatives  The Over- the- Counter derivatives

 The exchange traded derivatives are the
futures and options. The futures are standardized derivative contracts. The Euronext.liffe and the Chicago Mercantile Exchange are some derivative markets, to name a few.

The Over- the- Counter derivatives
 The derivatives traded over the counter
are known as the over the counter derivative market .The Over the counter derivative market consists of the investment banks and include clients like hedge funds, commercial banks, government sponsored enterprises etc.

What is a Cash Market
 The cash market is a buying strategy in which
the buyer makes an immediate payment that is equal to the current market price for commodities and other types of securities. Upon the receipt of the payment, the seller relinquishes all claims to the property and bestows ownership upon the buyer. In a sense, any type of retail transaction such as the purchase of groceries could be considered a cash market, as the goods are received by the buyer upon rendering a cash payment for the products

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