Derivatives Essay

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CONTENT
Introduction
Definition and basic concept of derivatives
Application of Derivatives
Trading Futures

Basic concept of derivatives
Futures Contract:- Future contract is between two parties.one is agrees to buy related underlying asset and other is agree to sale at a specified date and specified price. Both party get agree today for future deal in advance. All the terms are made by stock exchange other than price .Both party are protected against counter party risk by an entity called clearing corporation.by entrant of this corporation participating parties do not suffer by risk of defaulting its obligation. To fulfil guarantee of its obligation clearing corporation holds some amount as security from both parties. This amount is called margin of money and can be in the form of cash or other financial asset.
Spot Market:-It is a security market where securities are sold for cash and delivered immediately,The delivery happens after settlement period. Which is T+2
Terminology of Derivatives:-
Spot price:-This is price of an underlying asset which is quoted for immediate delivery of asset.
Forward price or Future price:-This is price at which both parties get agreed to trade commodity at specific future date. This price is dependent on spot price.

APPLICATION OF DERIVATIVES
There is a broad range of investors those invest in different category to manage their risk.These investors broadly categorize in three categories.
1. Hedgers
2. speculators
3. Arbitrageurs.
Hedgers
These investors have a position (i.e., have bought stocks) in the underlying market but are worried about a potential loss arising out of a change in the asset price in the future. Hedgers participate in the derivatives mark...

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... , the lower the loss. Similarly, if S T is greater than
F, the investor makes a profit and higher the S T, the higher is the profit.
Pay-off diagram for a short position is the pay-off diagram for someone who has taken a short position on a futures contract on the stock at a price F.
Short Futures
Payoff for Short Futures
Here, the investor makes profits if the spot price (ST) at expiry is below the futures contract price F, and makes losses if the opposite happens. Here, if ST is less than F, the investor makes

a profit and the higher the ST , the lower the profit. Similarly, if ST is greater than F, the investor makes a loss and the higher the S T, the lower is the profit.
As can be seen from the pay-off diagrams for futures contracts, the pay-off is depicted by a straight line (both buy and sell). Such pay-off diagrams are known as linear pay-offs

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