- When dealing in the stock market, you must have heard the term “Derivatives”
- A derivative is an agreement between two parties, which derives its value from an underlying asset, which may be stocks, currency, commodities, etc.
- It is mainly used as a tool for hedging, speculating as well as arbitraging.
- The common types of derivatives are options, futures, forwards, and swaps.
Let us understand the most common terminology which is associated with the derivatives market:
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- American Style Option: A type of option that can be exercised at any time unlike the European Style option which can only be exercised at expiry
- At-the-Market: A kind of financial transaction where the order to buy or sell is executed at the current market price.
- At-the-Money Spot: An option whose strike price is equal to the current market price in the cash spot market.
- At-the-Money Forward: An option whose strike price is equal to the current market price in the forward market.
- Call Option: It is a financial contract that gives the owner the right but not the obligation to buy a specific amount of the underlying financial instrument at a particular price with a specific date of maturity.
- Commodity Swap: A contract in which counterparties agree to exchange payments related to indices, at least one of is a commodity index.
- Currency Swap: A currency swap involves the exchange of an interest in one currency for the same in another currency.
- Delta: The change in the financial instrument’s price to changes in the price of the underlying cash index.
- Equity Swap: A contract in which counterparties agree to exchange payments related to indices, at least one of which is an equity index.
- European Style Option: An option that can be exercised only at expiry as opposed to an American Style option
- Forward Contracts: An over-the-counter obligation to buy or sell a financial instrument that is settled privately between the two counterparties.
- Futures Contracts: An exchange-traded obligation to buy or sell a financial instrument.
- Gamma: The degree of curvature in the financial contract’s price curve to its underlying price.
- Hedge: A transaction that offsets an exposure to fluctuations in financial prices of some other contract or business risk.
- In-The-Money Spot: An option with positive intrinsic value with respect to the current market spot rate.
- In-The-Money-Forward: An option with positive intrinsic value with respect to the current market forward rate.
- Option: The right but not the obligation to buy (sell) some underlying cash instrument at a specific rate on a particular expiration date.
- Premium: The cost associated with a derivative contract, referring to the combination of intrinsic value and time value.
- Put Option: A put option is a financial contract giving the owner the right but not the obligation to sell a particular amount of the underlying financial instrument at a pre-set price.
- Spot: The price in the cash market for delivery using the standard market convention.
- Strike Price: The price at which the holder of a derivative contract exercises his right.
- Theta: The sensitivity of a derivative product’s value to changes in the date, all other factors staying the same.
We hope now you will able to understand the derivatives terms when dealing in the same.