A derivative is a financial contract which derives its value from one or more underlying assets.The underlying asset could be stocks, commodities, bonds, currencies, market indexes or interest rates.
Derivatives can either be exchange traded or traded over the counter (OTC). Derivative traded on the exchange are standardized and regulated.These financial instruments help in making profit by simply betting on the future value of the underlying asset.
Derivative contracts like futures and options trades freely on exchanges and can be employed to satisfy variety of needs which includes the following-
>Hedge your securities
>Transfer of risk
>Benefit from arbitrage opportunities
Types of derivative:
Future – These are standardised version of forward contract which takes place between two parties where they agree to trade a particular contract at a specified time and at an agreed upon price.
Option – It is an agreement between a buyer and a seller which gives the buyer the right but not the obligation to buy or sell a particular asset at a later date at an agreed upon price.
1. Call option – It is an agreement which provides investor the right but not the obligation to buy specified amount of an underlying security at a stated price within a specified time.
2. Put option – It is an agreement which gives the owner the right, but not the obligation to sell stated quantity of the underlying security at a specified time and stated price.
