Basics

A Derivative is a financial instrument whose value depends upon the value of other, more basic, underlying variables. Some common examples include things such as stock options, futures, and forwards. It can also extend to something like a reimbursement program for college credit. Consider that if your firm reimburses 100% of costs for an A, 75% of costs for a B, 50% for a C and 0% for anything less.
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Basics
Your right to claim this reimbursement, then is tied to the grade you earn. The value of that reimbursement plan, therefore, is derived from the grade you earn.

We also say that the value is contingent upon the grade you earn. Thus, your claim for reimbursement is a contingent claim.
The terms contingent claims and derivatives are used interchangeably.
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Positions
In general if you are buying an asset be it a physical stock or bond, or the right to determine whether or not you will acquire the asset in the future (such as through an option or futures contract) you are said to be LONG the instrument. If you are giving up the asset, or giving up the right to determine whether or not you will own the asset in the future, you are said to be SHORT the instrument.

In the stock and bond markets, if you short an asset, it means that you borrow it, sell the asset, and then later buy it back. In derivatives markets you generally do not have to borrow the instrument you can simply take a position (such as writing an option) that will require you to give up the asset or determination of ownership of the asset. Usually in derivatives markets the short is just the negative of the long position
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Participants
Hedgers: These are investors with a present or anticipated exposure to the underlying asset which is subject to price risks. Hedgers use the derivatives markets primarily for price risk management of assets and portfolios. Speculators: These are individuals who take a view on the future direction of the markets. They take a view whether prices would rise or fall in future and accordingly buy or sell futures and options to try and make a profit from the future price movements of the underlying asset. Arbitrageurs: They take positions in financial markets to earn riskless profits. The arbitrageurs take short and long positions in the same or different contracts at the same time to create a position which can generate a riskless profit.

Types of Derivatives
1 ) Forward Contracts: These are promises to deliver an asset at a predetermined date in future at a predetermined price. Forwards are highly popular on currencies and interest rates. The contracts are traded over the counter (i.e. outside the stock exchanges, directly between the two parties) and are customized according to the needs of the parties. Since these contracts do not fall under the purview of rules and regulations of an exchange, they generally suffer from counterparty risk i.e. the risk that one of the parties to the contract may not fulfill his or her obligation.

2)Futures Contracts: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in future at a certain price. These are basically exchange traded, standardized contracts. The exchange stands guarantee to all transactions and counterparty risk is largely eliminated. The buyers of futures contracts are considered having a long position whereas the sellers are considered to be having a short position. Futures contracts are available on variety of commodities, currencies, interest rates, stocks and other tradable assets. They are highly popular on stock indices, interest rates and foreign exchange.

Distinction between Futures and Forwards

3) Options : Options give the buyer (holder) a right but not an obligation to buy or sell an asset in future. Options are of two types - calls and puts. Calls give 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. Puts give 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. One can buy and sell each of the contracts. When one buys an option he is said to be having a long position and when one sells he is said to be having a short position

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

Futures and Options

Futures Terminology

Options Terminology

Trading of F&O

Submitted by: Taniya Jain Varun Porwal Ayush Anand Tanvi Singh Janaki Puneet Ankit