the basics to mastering equities derivatives-futures and options

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Derivatives are financial products, such as futures contracts, options, and mortgage-backed securities. Most of derivatives' value is based on the value of an underlying security, commodity, or other financial instrument.For example, the changing value of a crude oil futures contract depends primarily on the upward or downward movement of oil prices.An equity option's value is determined by the relationship between its strike price and the value of the underlying stock, the time until expiration, and the stock's volatility.Certain investors, called hedgers, are interested in the underlying instrument. For example, a baking company might buy wheat futures to help estimate the cost of producing its bread in the months to come.Other investors, called speculators, are concerned with the profit to be made by buying and selling the contract at the most opportune time. Listed derivatives are traded on organized exchanges or markets. Other derivatives are traded over-the-counter (OTC) and in private transactions..

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In finance, "Derivatives are financial instruments whose price and value derive from the value of assets underlying them"[1]. Examples of the assets which can be referenced by a derivatives contract are diverse and may be anything from bars of gold (commodity derivatives), to stocks (equity derivatives), interest rates (interest rate derivatives), currency exchange rates (currency derivatives), credit risk of third party obligors (credit derivatives) and even the weather (weather derivatives) (see further below).Examples of the financial instruments used in derivatives transactions, which reference these underlying assets include: options, futures, swaps and forwards.Options are contracts wherein one party (the 'purchasor' or 'buyer') agrees to pay a fee (called a 'premium') to another party (called the 'grantor' or 'writer') for the right, but not the obligation. to buy something from or sell something to the writer, at a specified and pre-agreed price (called the 'striking price' or 'strike') on or before a date certain (called the 'expiration' of the option). There are two types of simple options: calls and puts. A call option gives its owner the right to buy something at the striking price on or before the option's expiration, and a put option gives its owner the right to sell something at the striking price on or before the option's expiration.For example, a person worried that the price of his XYZ stock might go down before he plans to sell it might buy an option, in this case a 'put' option, to sell his shares at a known price from a writer. If he or she decides to do so, the buyer will pay the option seller ('writer' is the usual term) a premium for the right to sell at the striking price.In this case, the purchasor of the option has the absolute right to sell his shares to the option writer at the agreed price, the strike, at any time during the life of the option, the option's expiration. If the option buyer does elect to use his option to sell, at any time prior to the option's expiration, this is known as 'exercising' the option. The option writer, should the buyer exercise his or her option, MUST purchase the option buyer's shares at the striking price, and pay the option buyer that sum of money, the striking price times the number of shares. In option trading, when the option buyer exercises his rights, the option seller is said to be 'assigned' the shares.The option buyer in this case is using an option, a put, to attempt to insure against the risk that his stock may go down in price, while the writer of the put option is using the option to earn the premium of the option as income. The option writer may or may not have the view that the price of the stock involved will decline; he or she in the usual case is principally concerned with earning the premium.A common usage of the other type of option, the call option, occurs when an owner of XYZ shares decides that XYZ may not be increasing in price over the near term. In an attempt to earn some income while XYZ's price is (as he or she expects) not moving higher, the XYZ owner might sell ('write') a call option to another party, granting the other party the right to buy the XYZ owner's shares at the striking price of the option, on or before the option's expiration. The call option buyer will, again, pay the premium of the option to the writer. Typically in this case, but by no means always, the XYZ share owner will select a striking price for the option that he or she wants to sell that is somewhat above the current market price of XYZ. The buyer of this call option, by purchasing the option, expects XYZ's price to move higher, perhaps much higher, before the option's expiration.Later, contracts known as interest rate swaps appeared, where one party agrees to swap cash flows with another. For example, a business may have a fixed-rate loan, while another business may have a variable-rate loan; each of the businesses would prefer to have the other type of loan. Rather than cancel their existing loans (if this is possible, it may be expensive), the two businesses can achieve the same effect by agreeing to "swap" cash flows: the first pays the second based on a floating-rate loan, and the second pays the first based on a fixed-rate loan (in practice, the two will net out the amounts owing). By swapping the cash flow, each has "converted" or "swapped" one type of loan into another.Derivatives can be based on different types of assets such as commodities, equities or bonds, interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) — see inflation derivatives — or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the payoffs. The main use of derivatives is to either remove risk or take on risk depending if one were a hedger or a speculator. The diverse range of potential underlying assets and payoff alternatives leads to a huge range of derivatives contracts available to be traded in the market. The main types of derivatives are futures, forwards, options and swaps. Derivatives are increasingly[citation needed] being used to protect assets from drastic fluctuations and at the same time they are being re-engineered to cover all kinds of risk and with this the growth of the derivatives market continues. It is, indeed, ironic that something set up to prevent risk will also allow parties to expose themselves to risk of exponential proportions.