Financial Derivatives Products

A derivative contract is a Financial Instrument whose value is derived from cash value of the underlying asset.Various financial derivatives contracts are :

Forward Contract  :  A Forward Contract is a customized arrangement between two parties to buy / sell an underlying asset at an agreed or contracted rate at certain time in future.They are mainly traded over the counter. No cash is exchanged when the contract is entered into.

Futures Contract : A futures contract is an agreement between two parties to buy / sell an asset at pre agreed price at certain time in future.They are mainly traded at organized exchanges. The parties involved get the settlement guarantee from the exchanges for their transactions.The contracts are standardized and their expiry dates are fixed.They have linear pay off values .

Option Contract : An Option is a derivative contract which gives one party right to buy / sell an underlying asset at pre agreed strike or exercise price on or before expiry date of the contract.The party which has the right (choice) pays the premium (option price) at the inception of the contract.The party which sells the option has the duty or obligation to perform that on or before expiry date.

To begin, there are two kinds of options: Call Options and Put Options

Call options

Call options give the buyer the right, but not the obligation, to buy the underlying asset at a pre-agreed price, on or before a expiry date.

Put Options

Put Options give the holder the right to sell a specific number of underlying assets at an pre-agreed strike price on or before a expiry date.

Summary :

CALL OPTION BUYER CALL OPTION WRITER (Seller)
  • Pays premium
  • Right to exercise and buy the shares at x
  • Profits from rising prices
  • Limited losses, Potentially unlimited gain
  • Receives premium
  • Obligation to sell shares if exercised by buyer
  • Profits from falling prices . keeps premium
  • Potentially unlimited losses, limited gain
PUT OPTION BUYER PUT OPTION WRITER (Seller)
  • Pays premium
  • Right to exercise and sell shares
  • Profits from falling prices . Exercises the right
  • Limited losses, Potentially unlimited gain
  • Receives premium
  • Obligation to buy shares if exercised by buyer
  • Profits from rising prices , keeps premium
  • Potentially unlimited losses, limited gain

 

Action Plan :

CALL OPTIONS> PUT OPTIONS
If you expect a fall in price(Bearish) Short Long
If you expect a rise in price (Bullish) Long Short