Lets talk about Derivatives!

What is Derivatives?

Derivatives is a financial contract or any product whose value is derived from its underlined asset. It means the value is depends on some else product price. Here, the underlined asset can be any:

Financial asset such as shares, bonds, debenture, etc.

Agri commodities such wheat, rice, bajra, etc.

Metal such as gold, silver, aluminum, etc.

Energy resources such as crude oil, electricity, coal natural gas, etc.

Products in Derivatives Market:

Forward:

It is an contract or agreement between the parties to buy and sell an underlined asset at a certain future date for a particular price that is pre-decided on the date of contract.

Futures:

A futures contract is similar to forward, except that the deal  is made through an organized and regulated exchange rather than being negotiated directly between two parties.

Options:

An Options is contract that gives the right, but not an obligation to buy or sell the underlying on or before a stated date and stated price. While buyer(holder) of the contract will a premium to buy a right, whereas, seller(writer) of the contract will receive the premium.

Swaps:

A swap is a type of derivatives in which two counterparties exchange cash flows based on an underlier. Here the underlier could be equities, commodities, Interest rates or Currency.

Market Participants:

There are three types of participant in the derivatives market which are Hedgers, speculator and Arbitrageur.

Hedgers: 

They face risk associated with the prices of underlying assets and use derivatives to reduce their risk. Corporations, institutions and banks all use derivatives products to hedge or reduce their losses from  market fluctuation such as interest rates, share value, bond prices, currency exchange rates and commodity prices.

Speculators:

They try to predict the future movements in prices of underlying asset and based on the view, take positions in derivatives contracts.

Arbitrageurs:

Arbitrage is a deal that produce profit by exploiting a price difference in a product in two different markets. It means a person buying product from one market and sell into another location market at high price.