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Different Types of Derivatives

By News Canvass | Nov 14, 2022
Derivatives

The Indian Stock Market makes it simple to trade four different forms of derivatives. Each derivative is distinct from the others and has its own unique set of contract terms, risk factors, and other elements.

The following are the four various derivatives:

  • Forward Agreements
  • Future Agreements
  • Options Agreements
  • Swap Agreements

Forward Contracts

By entering into a forward contract, two parties agree to acquire and sell an underlying asset at a future specified date and predetermined price. To put it another way, it is an agreement made between the two parties to sell their asset at a later point.

The customized forward contracts have a high propensity for counterparty risk. The size of the agreement is fully dependent on the length of the contract because it is a customizable one.

Since forward contracts are self-regulatory, no collateral is needed. The forward contracts are settled on the maturity date; therefore, they are reserved by the expiration date.

Future Contracts

Forward contracts and future contracts are similar. Future contracts are agreements between two parties to purchase or sell an underlying asset at a predetermined price at a later time.

Future contracts prohibit the buyer and seller from meeting in person and concluding a deal. In actuality, the exchange mode is used to finalize the purchase.

Because futures contracts are standardized contracts, the counterparty risk is minimal. Additionally, the clearinghouse functions as a counterparty to the contract’s parties, lowering future credit risk.

Simply because a futures contract is characterized as a standardized contract, its size is predetermined, and it is governed by the stock exchange.

Options Agreements

The third category of derivative contracts in India is options contracts. Options contracts differ greatly from future and format contracts because there is no requirement that the contract be discharged on a specified date.

Options contracts grant the right to buy or sell an underlying instrument, but not the obligation.

Two choices are included in option contracts:

Call Choice

Put Choice

In a call option, the buyer has the full authority to enter into contracts for the purchase of an underlying asset at a defined price. The buyer has the full right, but not the responsibility, to sell the underlying asset at a specified price while entering the contract while exercising the option.

However, the buyer decides to settle every contract on or before the expiration date in both call and put option contracts.

Anyone who routinely trades in option contracts can therefore choose any of the four positions, i.e., short or long, either in the call option or the put option. Both the stock exchange and the over-the-counter market are used to trade these options.

Swap Agreements

Swap contracts are among the most complicated of the three derivatives contracts.

 

Swap contracts signify a private arrangement between the parties. The parties to swap contracts consent to exchanging their future cash flow according to the pre-established formula.

Since these contracts shield both parties from a number of significant risks, the fundamental security in swap contracts is either the interest rate or the currency.

Since investment bankers operate as a sort of middlemen between these contracts, they are not traded on the Stock Exchange.

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