Investment Sight

Before investing your hard earned money into the derivatives market, you need to understand the different types of derivative contracts available to purchase and which one is best suited for you. Derivative contracts are broadly categorized into four distinct groups:

A)   Futures:

These are standardized contracts for buying or selling specified commodities at certain date in future at the market price. The prices are determined by the balance between supply and demand of the commodity at that time. Basically, the traders of futures are placed in two groups: hedgers and speculators. Hedgers include consumers and producers of the commodity or owners of the asset.

B)   Forwards:

A forward is a kind of agreement between the two parties for buying or selling a commodity in future for a specified price agreed today. This agreed price is termed as delivery price and is equal to the forward price when the contract was purchased. A forward contract is very much similar to a futures contract, expect that it is not exchange traded or defined on the standardized assets. Because these contracts are sold out over the counter, the specifications of the contracts can be customized and may even include daily and mark to market marginalize.

C)   Options:

These are contracts between buyers and sellers, giving the buyers the right and not an obligation, to sell or buy a particular commodity before or on the specified date. The risk associated with granting, trading or owning option contracts can be managed and quantified more precisely than with other such investments. Different types of options may include employee stock options, prepayment options, real estate options etc.

D)   Swaps:

These are derivative contracts in which certain benefits of one party’s financial instruments are exchanged with the others. These contracts define the dates on which cash flows need to be paid and also the ways by which they are calculated. Swaps can also be used for creating unfunded exposures to underlying assets, since the counter-parties are earning profits or bearing loss due to movements in the price. Swaps may be used for hedging certain risks like interest rate risks or for speculating on the changes in the underlying prices. Further, swaps can be of different types including interest rate swaps, currency swaps, commodity swaps, equity swaps, credit default swaps, total return swaps, variance swaps, constant maturity swaps and amortizing swaps.

By understanding all these types of derivative contracts, you will be able to make an informed decision, while investing in the derivatives market.