What are derivatives?
The Term “Derivative” stands for a contract (Financial Instrument) whose price is derived from or is dependent upon an underlying asset. The Underlying asset could be a financial asset such as Currency, Stock, Physical Commodity, Market Index & an interest bearing Security.
Major advantages of applying derivatives is providing hedging against price fluctuations, lower transaction cost, leverage as well as benefitting from arbitrage opportunities.
Derivatives can be further classified as Futures & Options where a Futures Contract is an agreement made through an organized exchange to buy or sell a fixed amount of a commodity or a financial asset on a future date at an agreed price while An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying asset on or before a stated date, at a stated price, for an agreed upon price.
Futures & Options can be used by market participants to Hedge, Speculate or for arbitrage purposes.