Some commonly used Derivatives

Here we define some of the more popularly used derivative contracts.

Forwards : A forward contract is an agreement between two entities to buy or sell the underlying asset at a future date, at today’s pre-agreed price.

Futures : A future contract is an agreement between two parties to buy or sell the underlying asset at a future date at today’s future price. Futures contracts differ from forward contracts in the sense that they are standardized and exchange traded.

Options : There are two types of options – Call and Put. A call option gives the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. A Put option gives the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

Warrants : Options generally have lives of up to one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer dated options are called warrants and are generally traded over the counter.

Baskets : Basket options are  options on portfolios of underlying assets. The underlying asset are usually a weighted average of a basket of assets. Equity index options are a form of a weighted average of a basket of assets. Equity Index Options are a form of basket options.

Swaps : Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The Two commonly used swaps are :

Interest rate swaps : These entail swapping only the interest related cash flows between the parties in the same currency.

Currency Swaps : These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction