The term derivative refers to a type of financial contract whose value/structure is derived from some other asset.
It is dependent on an underlying asset, group of assets, or benchmark. A derivative is set between two or more parties that can trade on an exchange or over-the-counter (OTC).
CASH Price/ SPOT Priece
The price of underlying asset is reffered as cash price or spot price.
P&L
The change in the value of an investment or a financial position is reffered as P&L
Types of derivatives
Forward and Futures
These are the contracts that lock in the price two parties will buy and sell an asset at some future date.
Forwards vs. Futures
Forwards
- Trade OTC
- Customizable terms
- Often no upfront cost
- Higher counterparty risk
- Ex- Onion
Futures
- Trade on listed exchanges
- Standardized terms
- Contracts must be paid for with an initial margin
- Very low counterparty risk
- Ex- oil
Options
Options are financial instrument that were designed to be priced based on the value of underlying asset. As you plan a trade, you must think in terms of three things:
>> The Underlying
>> The Options
>> What are the algos and other market participants such as day traders may do at any time during the day
There are two types of Options – Calls and Puts.
Swaps
Swaps are linked to intrest rates, allowing a floting intrest rate to be switched to a fixed rate.
Market of derivative
Derivative are traded on either OTC( over the counter) or an organised exchange. OTC contracts are bilateral deals between two parties, there is always a risk that one of them could fail to meet their contractual obligations.
Organised exchange which trade derivatives are New york exchange, Chicago Mercantile Exchange , and Euronext for example.
Exchnage traded Product are standarised and there is a high degree of price transparency. Also, Exchange traded product have much less exposure to counterparty risk ( default risk).
Details
Forward
Forward contract is an agreement between a seller and a buyer in which they agreed that seller will sell an asset to the buyer at a certain time in the future at a price agreed upon at a time entering the contract.