These four categories are what we call the 4 basic types of derivative contracts. In this article, we will list down and explain those 4 types:
1.
Futures Contract:- A futures contract is
very similar to a forwards contract. The similarity lies in the fact that
futures contracts also mandate the sale of commodity at a future data but at a
price which is decided in the present. However, futures contracts are listed on
the exchange. This means that the exchange
is an intermediary. Hence, these contracts are of standard nature and the
agreement cannot be modified in any way. Exchange contracts come in a
pre-decided format, pre-decided sizes and have pre-decided expirations.
2.
Forward Contracts:- Forward contracts are the simplest form of derivatives that
are available today. Also, they are the oldest form of derivatives. A forward
contract is nothing but an agreement to sell something at a future date. The
price at which this transaction will take place is decided in the present.
3.
Option Contracts:
The
third type of derivative i.e. option is markedly different from the first two
types. In the first two types both the parties were bound by the contract to
discharge a certain duty (buy or sell) at a certain date. The options contract,
on the other hand is asymmetrical. An options contract, binds one party whereas
it lets the other party decide at a later date i.e. at the expiration of the
option. So, one party has the obligation to buy or sell at a later date whereas
the other party can make a choice. Obviously the party that makes a choice has
to pay a premium for the privilege.
There are two types of options i.e. call
option and put option. Call option allows you the right but not the obligation
to buy something at a later date at a given price whereas put option gives you
the right but not the obligation to sell something at a later date at a given
pre decided price.
4.
Swaps: Swaps are probably the most complicated derivatives in the
market. Swaps enable the participants to exchange their streams of cash flows.
For instance, at a later date, one party may switch an uncertain cash flow for
a certain one. The most common example is swapping a fixed interest rate for a
floating one. Participants may decide to swap the interest rates or the
underlying currency as well.
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