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Derivatives

What are the types of Derivatives

Forwards :

A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s pre-agreed price.

Futures :

A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts, such as futures of the Nifty index

Options

Is a contract which gives the right, but not an obligation, to buy or sell the underlying at a stated date and at a stated price. While a buyer of an option pays the premium and buys the right to exercise his option, the writer of an option is the one who receives the option premium and therefore obliged to sell/buy the asset if the buyer exercises it on him. Options are of two types:

  • ‘Calls’ give the buyer the right, but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date.

  • ‘Puts’ give the buyer the right, but not the obligation to sell a given quantity of underlying asset at a given price on or before a given future date.

Types of options

Options can be divided into two different categories depending upon the primary exercise styles associated with options. These categories are:

European Options

European options are options that can be exercised only on the expiration date. All options based on indices such as Nifty, Mini Nifty, Bank Nifty, CNX IT traded at the NSE are European options which can be exercised by the buyer (of the option) only on the final settlement date or the expiry date.

American options

American options are options that can be exercised on any day on or before the expiry date. All options on individual stocks like Reliance, SBI, and Infosys traded at the NSE are American options. They can be exercised by the buyer on any day on or before the final settlement date or the expiry date.

What is an ‘Option Premium’

At the time of buying an option contract, the buyer has to pay premium. The premium is the price for acquiring the right to buy or sell. It is price paid by the option buyer to the option seller for acquiring the right to buy or sell. Option premiums are always paid up front.





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