A financial derivative is an instrument whose value depends on the performance of another (the underlying) asset. For e.g, stock option
5 major types of derivatives
3. Forward contracts
4. Options on Futures
Uses of derivatives
Definition: A contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a pre-determined price on a pre-determined date in the future.
Long Position: Means you have purchased a futures contract. Allows you to buy the underlying instrument.
Short position: Means you have sold a futures contract. Obligated to sell the underlying instrument at a predetermined price.
Futures Price (Delivery Price): The pre-determined price.
Maturity Date (Delivery Date): The pre-determined date. Usually a window of days (2-3 weeks)
If today you purchase an October Orange juice futures contract for $1 per gallon. You are agreeing to pay that specified price when the contract matures in October. It doesn’t matter how much the price of orange juice changes, you will only have to pay $1 per gallon for the orange juice. Money swaps hands when contract matures and delivery is received.
1. Commodities – agricultural, metals, energy
2. Financial – interest rate, currency, index
3. Nonconventional- snowfall, weather, water, single-stock futures
Single stock futures- a futures contract on individual stocks. A one Chicago single stock futures contract is an agreement to deliver 100 shares of a specific stock at a designated date in the future called and expiration date
2. Futures Exchanges
a. 24-hour- globex for international trading.
b. Membership- floor traders (trade for their own accounts) and floor brokers ( trade for others and earn commission). Floor brokers use trading pits.
c. open-outcry and