A Brief Overview of Common Derivatives in the Financial Market

A Brief Overview of Common Derivatives in the Financial Market

A Derivative is a contract/agreement between the parties for deriving a value of an underlying security/asset based on its performance. The underlying assets include commodities, stocks, bonds, currencies etc. Derivatives offer an opportunity to the investor/trader to participate in the price fluctuations of the underlying asset. Below are the most commonly used derivatives in the financial markets.

1) Options:

In the financial market, there are two familiar terms that are often spoken “call option” and “put option”. This is used in the option derivatives. Options are the type of contract entered between the parties that grant the buyer (owner or holder of the option) the right of the underlying asset but not the obligation to buy or sell the same at a set price, technically called as “strike price” on or before a specified period or date. The right to buy is called a “call option” and the right to sell is called a “put option”. The strike price may be set based on the market price or at a discount/premium value. Options are traded on the exchange and over the counters.

2) Warrants:

Warrants are the security entitling the buyer (i.e. the holder) to buy the underlying asset at a fixed price called exercise price at the predetermined period/date. They are similar to the option derivatives. Warrants are in general attached to bonds or preferred stock. A Warrant is exercised when the holder informs the issuer (mostly the company) their intention to purchase the security underlying the warrant. Warrants carry long exercise period as compared to options and they are commonly traded over-the-counter. A Warrant must be exercised before the expiry date. A holder has to consider aspects such as premium i.e. the extra amount to be paid for the purchase, leverage, expiration date and exercise restrictions.

3) The contract for Difference:

The contract for Difference is trading on the price movements of an underlying asset. This is again an agreement between a buyer and seller to exchange the difference between the current price and end price of an underlying asset at the end of the contract. If the difference (technically called “spread”), is positive, the seller pays the buyer. If the spread is negative, the buyer pays the seller. The primary advantage of CFD is that it allows the traders to trade in any underlying security without actually owning them. Since the trader does not hold any securities, he/she does not hold any rights/obligation from that asset. They are also called as forwarding contracts for difference. CFD trades are even carried on the digital currency – cryptocurrency that is spinning the entire financial market. Since the market for cryptocurrencies is highly volatile, CFD traders make a massive profit from price fluctuations. Crypto CFD Trader is a trading software that is used by many CFD traders to track the market volatility and trends of cryptocurrencies.CFD traders enjoy a huge profit when the price of cryptocurrencies moves according to the position entered as per the contract.

Derivatives are an effective method to offset the risk arising from the price fluctuation of security. They potentially save investors from losing substantial money from adverse price movements of securities.

 

    Vanessa Chambers