Derivative
Candlefocus EditorDerivatives are financial contracts that derive their value from an underlying asset, group of assets, or benchmark. They can either be traded on an exchange or over-the-counter, and the pricing of these derivatives are dependent on the movements of the underlying asset. They are commonly used by investors, hedgers, and speculators as a way of limiting their risks and taking advantage of short term speculative opportunities.
Derivatives are usually leveraged instruments that can have a significant impact on the overall performance of an investor’s portfolio. As a result, they also have the potential to create high profits or large losses, depending on how they are used. Therefore, it is important to carefully consider the risks and rewards associated with investing in derivatives before making a decision.
Common Types of Derivatives
Futures Contracts: A futures contract is an agreement to buy or sell a predetermined amount of an underlying asset at a predetermined price, on a predetermined date. The underlying asset for a futures contract is usually a commodity or a financial instrument, such as a currency. For example, a futures contract might be for the purchase of 100 barrels of crude oil at $60 per barrel on June 1.
Forwards: Forwards are similar to futures contracts in that they involve two parties agreeing to buy or sell an underlying asset in the future at a predetermined price and date. However, forwards are a privately negotiated contract and are not traded on an exchange like futures contracts are.
Options: An option is a contract between two parties in which one party has the right but not the obligation to buy or sell a predetermined amount of an underlying asset at a predetermined price on or before a predetermined date. Options are typically used to hedge against price movements of an underlying asset.
Swaps: A swap is an agreement in which two parties exchange interest payments or cash flows over a certain period of time. Swaps are typically used to hedge against interest rate risk.
It is important to keep in mind that derivatives are speculative investments, and should be used with caution. Before investing in derivatives, it is important to thoroughly research the underlying asset and to understand the risks and rewards associated with these products. Doing so will help ensure that the risks are minimized and will ultimately lead to a better return on investment.