Derivative Trading

Derivatives are contracts that give the holder the right to buy or sell some underlying asset. It consists of future and options contracts which means that they derive their value from some other underlying security or index.

Futurescontracts guarantee delivery of a specific quantity of a specified asset on a specified future date, at the price currently quoted. If an investor anticipates the spot price on the delivery date to be higher than the quoted futures price today, then he or she may buy the contract hoping to make a profit. But, if an investor anticipates the spot price to be lower than today’s quoted futures price, then the contract could be sold. Positions in futures contracts can be offset prior to the delivery date.

Options consist of Call and Put. For example, a call option on an equity share gives the holder the right to buy the underlying at a specific price known as the strike price. On the other hand, a put option gives the holder the right to sell the underlying at a specific price. A call option would be bought if the buyer expects the price of the underlying to rise, while a put option will be bought if the buyer expects the underlying to decline. The seller of the option is also known as the writer of the option. While the holder of the option is under no obligation to perform any action, it is the writer who is obligated to perform, that is, deliver securities on exercise of a call, or make payment on exercise of a put. For granting the privilege of either buying or selling a stock, the writer receives a payment known as premium. Option positions can be offset prior to expiry.