Chapter 5
Derivatives
Derivative instruments (also known as derivative contracts) are financial contracts whose value depends upon the value of an underlying instrument or asset (typically a commodity, bond, equity or currency, or a combination of these).
There are two main classes of derivative contracts – exchange traded derivatives and OTC (over the counter) derivatives.
5.1 EXCHANGE TRADED DERIVATIVE CONTRACTS
As the name implies, these contracts are devised by and traded on investment exchanges, such as the Euronext.LIFFE exchange in London, the Chicago Board of Trade and the Eurex exchange in Frankfurt. These exchanges devise, standardise and provide trading facilities or a wide range of futures and options based on underlying instruments such as exchange rates, interest rates, government bonds, equity indexes, individual equities, as well as commodities such as wheat, copper and oil.
Exchanges provide two forms of derivative contracts – traded options and futures.
5.1.1 Traded options
There are two forms of traded options – put options and call options. A call option gives the buyer (or holder) the right (but not the obligation) to purchase the underlying instrument at a specified price (known as the strike price) on or before a given date known as the exercise date. A put option on the other hand gives the buyer (or holder) the right (but not the obligation) to sell the underlying instrument at a specified price on or before a given date. In order to acquire the rights ...
