Options, Futures and Other Derivatives: Global Edition

Product Information

Define derivatives, describe the features and uses of derivatives, and compare linear and non-linear derivatives. Non-linear derivatives require an upfront premium to be paid by both parties involved in the contract. Derivatives can greatly increase leverage. When the price of the underlying asset moves significantly and in a favorable direction, options magnify this movement. Trading Derivatives Long exposure in a futures contract means the holder of the position is obliged to buy the underlying instrument at the contract price at expiry. The holder will make a profit if the price of the instrument goes up.

Some corporate bonds may have derivatives embedded in them. These derivatives will give the bond issuers and holders the right to repay them or redeem them early/ convert them to shares respectively. Arbitrage opportunities exist when prices of similar assets are set at different levels. Therefore, an arbitrageur attempts to make a risk-free profit by buying the asset in the cheaper market and simultaneously selling it in the overpriced market.

Hedgers

An option gives the buyer the right, but not the obligation, to buy (or sell) an asset at a specific price at any time during the life of the contract.

Note that future contract offers similar payoffs as forward contracts. However, futures contracts trade on exchanges; that is, the underlying asset and possible maturity date are clearly stated in the contract.The asymmetry in the payoff profile allows for limited loss (the premium paid) with unlimited potential gain.