Futures and Options

Derivatives market futures and options

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What are futures and options?

Commodity Online Special | August 01, 2007 14:36 IST

Futures and options represent two of the most common form of "Derivatives". Derivatives are financial instruments that derive their value from an 'underlying'. The underlying can be a stock issued by a company, a currency, Gold etc., The derivative instrument can be traded independently of the underlying asset.

The value of the derivative instrument changes according to the changes in the value of the underlying.

Derivatives are of two types - exchange traded and over the counter.

Exchange traded derivatives, as the name signifies are traded through organized exchanges around the world. These instruments can be bought and sold through these exchanges, just like the stock market. Some of the common exchange traded derivative instruments are futures and options.

Over the counter (popularly known as OTC) derivatives are not traded through the exchanges. They are not standardized and have varied features. Some of the popular OTC instruments are forwards, swaps, swaptions etc.

Futures

A 'Future' is a contract to buy or sell the underlying asset for a specific price at a pre-determined time. If you buy a futures contract, it means that you promise to pay the price of the asset at a specified time. If you sell a future, you effectively make a promise to transfer the asset to the buyer of the future at a specified price at a particular time. Every futures contract has the following features:

  • Buyer
  • Seller
  • Price
  • Expiry

Some of the most popular assets on which futures contracts are available are equity stocks, indices, commodities and currency.

Yield Hunters' New Tune Echoes Financial Engineering's Past  — Wall Street Journal
And fresh geopolitical angst is again pushing yields lower on benchmark government debt. All this creates incentives for financial engineering.

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