Futures and Options – The basics.

Types of derivatives 1 – Forward contract.

Let’s catch up with the oldest and the simplest of derivatives.

FORWARD CONTRACTS

In forward contracts, two persons enter into an agreement for purchase and sale of a commodity / financial asset at a specified price at a specified future date. These contracts are generally used by traders to guard against price volatility.

  • For example- You are a trader of fruits. You enter into a contract with a farmer to deliver 1000 kilograms of apples at 100 per kilo, 3 months from now. That’s a forward contract. Here, apples are the specified asset, 100 per kilo is the specified price and 3 months is the specified future date.

So, in short, it is a contract between a buyer and a seller-

  • To deliver some goods / asset at a particular price at a future date, the price being fixed right now. On the delivery date, the buyer pays the price and receives the asset/goods
  • These are tailor made contracts and one can choose the quantity, mode of delivery and time of contract maturity.

What if one party to the contract does not oblige?

10 Comments

Introduction to Derivatives.

Derivatives have become very popular during the past two decades. The real purpose of derivatives is to allow traders to maximise returns and simultaneously limit their risk exposure. However, common investors have developed speculative interest with derivatives. It’s a complex subject and here, I am trying to crack down this subject in a step by step approach. May be you are not used with the term ‘derivatives’ but if I say  ‘Futures and options’ or ‘F & Os’ or ‘calls and puts’ I’m sure all of you would understand what I’m talking about.


19 Comments