CandleFocus Glossary Editor
Equity Derivatives, What are they?
Equity derivatives are financial instruments that are dependent on the movements in price of an underlying asset, typically a stock or stock index. Investors will often use these derivatives to either speculate or manage risk within their stock portfolios. Equity derivatives are typically split into two categories – equity options and equity index futures, although there are also other forms of equity derivatives such as equity swaps, warrants and single-stock futures.
This article will discuss in detail what equity derivatives are, how they are used and the different types of equity derivatives available to investors.
Equity Options
An equity option is a type of derivative that gives the buyer the right (not the obligation) to buy or sell a particular stock at a pre-set price, known as the ‘strike price’, before the option expiry date. Generally, if the stock’s price moves beyond the strike price then the option gains in value.
On the day of expiration, the buyer can either exercise their option, meaning they purchase the stock at the strike price, or they can buy or sell it on the open market, or simply let the option expire worthless. There are a variety of different types of equity options, such as American-style or European-style options.
Equity Index Futures
An equity index future is a derivative security that is linked to an equity index such as Dow Jones Industrial Average or the S&P 500. The contract size of the future will vary, depending on the index that it is tracking, and it will be for a fixed quantity of shares, allowing the investor to gain exposure to a large portion of the market without actually owning any of the underlying assets.
The investor is able to hedge their position and minimize the risk that they take, as the futures contract will be based on movements in the index, rather than the individual stocks within it. Investing in futures has lower margins and costs than investing in stocks, and the investor is able to obtain significant leverage, making them a popular choice for traders looking to invest in the market.
Other Equity Derivatives
Equity swaps allow investors to exchange one type of return for another, such as exchanging market or interest rate exposure or the return on an equity index for a return on a stock or bond. Warrants are similar to options, however, they are issued by the company and thus do not trade on an exchange. Finally, single-stock futures are similar to the equity index futures, but are based on the movements of a single stock instead of a basket of stocks.
In Summary
Equity derivatives are a type of financial instrument that is derived from the movements of an underlying asset, typically a stock or stock index. Traders and investors use equity derivatives to either speculate or manage risk in their portfolios. Equity derivatives are typically split into two categories, equity options and equity index futures, although there are other forms, such as equity swaps, warrants and single-stock futures. Equity derivatives offer considerable leverage and the ability to hedge positions, making it a popular choice for those looking to invest in the stock market.
Equity derivatives are financial instruments that are dependent on the movements in price of an underlying asset, typically a stock or stock index. Investors will often use these derivatives to either speculate or manage risk within their stock portfolios. Equity derivatives are typically split into two categories – equity options and equity index futures, although there are also other forms of equity derivatives such as equity swaps, warrants and single-stock futures.
This article will discuss in detail what equity derivatives are, how they are used and the different types of equity derivatives available to investors.
Equity Options
An equity option is a type of derivative that gives the buyer the right (not the obligation) to buy or sell a particular stock at a pre-set price, known as the ‘strike price’, before the option expiry date. Generally, if the stock’s price moves beyond the strike price then the option gains in value.
On the day of expiration, the buyer can either exercise their option, meaning they purchase the stock at the strike price, or they can buy or sell it on the open market, or simply let the option expire worthless. There are a variety of different types of equity options, such as American-style or European-style options.
Equity Index Futures
An equity index future is a derivative security that is linked to an equity index such as Dow Jones Industrial Average or the S&P 500. The contract size of the future will vary, depending on the index that it is tracking, and it will be for a fixed quantity of shares, allowing the investor to gain exposure to a large portion of the market without actually owning any of the underlying assets.
The investor is able to hedge their position and minimize the risk that they take, as the futures contract will be based on movements in the index, rather than the individual stocks within it. Investing in futures has lower margins and costs than investing in stocks, and the investor is able to obtain significant leverage, making them a popular choice for traders looking to invest in the market.
Other Equity Derivatives
Equity swaps allow investors to exchange one type of return for another, such as exchanging market or interest rate exposure or the return on an equity index for a return on a stock or bond. Warrants are similar to options, however, they are issued by the company and thus do not trade on an exchange. Finally, single-stock futures are similar to the equity index futures, but are based on the movements of a single stock instead of a basket of stocks.
In Summary
Equity derivatives are a type of financial instrument that is derived from the movements of an underlying asset, typically a stock or stock index. Traders and investors use equity derivatives to either speculate or manage risk in their portfolios. Equity derivatives are typically split into two categories, equity options and equity index futures, although there are other forms, such as equity swaps, warrants and single-stock futures. Equity derivatives offer considerable leverage and the ability to hedge positions, making it a popular choice for those looking to invest in the stock market.