Basic Introduction to Derivative

New ideas, technology, and innovations have always been the trademark of growth of mankind. In all ways and in all facets of life, humans are searching innovative ways and agendas that help increase profits and reduce risks. Similar is the case with financial markets where the present day people are investing to ensure high returns and simultaneously reduce the risk factor.

There are many innovations experienced by the financial market and one of the key innovations is the derivative. It is a financial product introduced with a key purpose of increasing returns and reducing risks. The value of these products is derived from other basic variables available in the market underlying the asset, index, or reference rate. These are called derivatives because they don’t have their own value or existence but derive from either assets or indices to ensure minimized risks.

There are mainly two types of derivatives, namely Over-The-Counter derivatives (OTD) and the Exchange-Traded derivatives (ETD). Based on these two derivatives there are several variants or products like futures, forwards, options, warrants, LEAPS, baskets, and swaps. Future is an agreement between two parties to trade an asset at a specified time in the future at a certain price. Forward is a customized trading between two whose settlements is done in future at a pre-agreed price and time. Options entitle the owner to trade an asset without any kind of obligation to buy or sell in future. Warrants are longer-term options that are usually traded over the counter. LEAPS is Long-Term Equity Anticipation Securities that have a maturity period of up to three years. Baskets are options on the portfolio of some underlying base or asset. Swaps are private agreement or mutual understanding between two individuals or parties to exchange cash flow in future with regards to the agreement signed in the present.

The derivative market is influenced by certain factors based on which the growth of financial derivates is driven. Some of the key factors responsible for driving the growth are increased volatility in asset prices, market improvement, development of risk management tools, and increased integration of financial markets across the world.

Derivatives are the best for trade as they protect the investors from the vagaries of the market. These offer low transaction cost and facilitates the investors to extend their settlement through future agreement. These provide an additional channel and also offer extra liquidity in the stock market. The entire range of derivative product is definitely as asset for the investors.