Derivative contracts have several variants. The most common variants are forwards, futures, options and swaps. We take a brief look at various derivatives contracts that have come to be used.
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.
OPTIONS: Options are of two types, CALLS and PUTS. 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 the underlying asset at a given price on or before a given date.
WARRANTS: Options generally have lives of upto one year. the majority of options traded on options exchanges having a maximum maturity of nine months. Longer dated options are called warrants and are generally traded over the counter.
LEAPS: The acronym LEAPS means long term equity anticipation securities. These are options having a maturity of upto three years.
BASKETS: Basket options are options on portfolios of
underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options.
SWAPS: Swaps are private agreements between two parties to exchange to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are INTEREST RATE SWAPS and CURRENCY SWAPS. Interest rate swaps entail swapping only the interest between the parties and currency swaps entail swapping both the principal and interest between the parties.
SWAPTIONS: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating.
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