What is Derivatives Trading and How is it Useful in the Global Trading Arena?
What is a Derivative?
A bond between two or more teams whose cost is supported by a monetary asset, that is settled upon by those parties, is a derivative. These financial assets can be capital or more like a security, which may also include bonds, currency, stock prices, commodities, etc.
The Basic Understanding of a Derivative
In the sphere of investing, derivatives are understood as tributary assets which hold value, only if they are linked to the primary ones. As an individual term, a derivative holds no value, but actually only derive their value from the primary asset. Examples of derivatives are: Stock options and future contracts.
A future contract stands as a derivative because its value solely depends and fluctuates in respect to an underlying asset. Similarly, stock options are derivatives because they derive their value from an underlying stock and its price.
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What are Traded Derivatives?
If we look at the derivative trading in broader terms, we will see ‘Over the Counter’ (OTC) derivatives, which consist of those contracts that are ‘privately negotiated’ and operated. This is done directly by the two sides without any intermediary or a middleman. Since each deal between two parties is custom designed, it is unique in terms of asset quality and its type, its expiration date, contract guidelines, etc. generally speaking, the price is not announced out in the public domain.
How are Derivatives valued?
As discussed earlier, different derivatives have totally different mechanisms for pricing. The pricing of a derivative is solely based on the value of its underlying asset. When the acquisition of a derivative is first done in derivative trading, a derivative, on the basis of the asset, is placed as a liability or an asset. This the fair value of the derivative which is subsequently also known to the market.
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