There are different types of derivatives available in share markets which are recognized as financial instruments. Share market experts accept derivatives as contracts between two or more parties (one type of security) that are practiced for trading or for share markets. The fluctuation of price and value of a derivative totally depends upon one or more financial assets.
In western developed economies there are various types of derivatives that are introduced much before. In National Stock Exchange of India, types of derivatives are used almost 10 years back. A few years after its released date in NSE and BSE, derivatives occupied an important financial platform to earn profit for shareholders or traders. Now these different types of derivatives are integral parts of Indian share markets.
It is very necessary to understand what these different types of derivates are and their exclusive uses before going for any derivative finance or derivative trading. A proper knowledge on various types of derivatives will increase the chances to procure a handsome profit out of a financial contract. Let us understand then basic types of derivatives in a financial market one by one.
One of the types of derivatives include forwards derivative contract. Here, a customized financial contract is determined by participants on the basis of a pre-agreed price. The settlement for such type of derivative is made on a specific date in future. In future on that very date payment will take place for forwards derivative contract.
Like forwards there are futures that come under basic types of derivatives. This is a special type of contract where an agreement in settled generally between two parties to sell or buy a financial asset. The financial contract would be sold or bought on a certain price and on a certain date in future. So, in other words, futures are nothing but simply a standard form of forwards derivative contracts.
The main difference between a future type of derivative and a forward type of derivative is that the technique while running futures is different. On the other hand, forwards are customized or tailor-made and futures are standardized. Types of derivatives like forwards are written by parties themselves. But, futures derivatives are written by those who operate buying and selling of financial assets or where buy or sell of a financial contract is done. They are called clearing house and they provide standardized types of derivatives like futures contract.
In a share market there are types of derivatives which are accepted as rights but they have no obligations for buying and selling process of financial assets. These types of derivatives contracts or financial instruments are called options. Options derivatives are of again two types- calls and puts. Call options provide a buyer the right but leaves with no obligation to buy a financial contract. A predetermined price is settled before determining a future date within two parties. On the other hand, put options offers the right to a buyer again but provides no obligation to sell a financial instrument.
Options are commonly used financial contracts which are generally end within one year of timing. But, there are warrants which are also included in types of derivatives. Warrants are options only but they have long-term validity. Warrants are traded over-the-counter rather then short-dated options derivatives. Types of derivatives like warrants have more than one year period as a maturity term.
Swaps are different types of derivatives which are accepted as private agreement or financial contract between two parties. Swaps financial contracts typically refer to cash flow exchanges made between two parties. Swaps allow a company to borrow capital at a floating rate that is at a fixed interest rate. It is similar to taking a loan from a bank at a fixed interest or at a floating rate.
like swaps are used in two ways- one is the interest rate swaps which is mentioned above and another is swaps. Currency swaps include both principal and interest exchanges for financial contracts. Here, different currency flow is made in one direction and cash flow exchange is made in another direction among traders, shareholders or stockholders.
Apart from these other types of derivatives are leaps, baskets and swaptions. Swaptions are options that include buying and selling of a swap till expiry of options and financial settlement date. Leaps securities are anticipated for long-term equity. Leaps derivatives have options to operate financial instruments for three years.
like baskets (for example equity index options) are options that are determined on the basis of the portfolios of underlying financial assets. Thus, different types of derivatives stand out in a share market as financial instruments.