Article

Derivative
June 07 , 2012

A simple transaction is to pay cash and buy a product (say soap) immediately. But you can have this transaction structured in other ways. One is to agree to buy this at a future date, instead of today. The other is to have a right to buy this later if one wants, but also the right to not buy. Such types of complex transactions are called derivatives, since they are offshoots of the basic product itself. Any standalone product (or item in general) can have derivatives associated with it – shares, commodities, interest rates, exchange rates, even the weather or monsoon. As with any market, it only requires a buyer and seller – someone who feels this item will go one way (say there will be a monsoon failure) and another who believes it will go the other (plentiful monsoon).

There are two basic types of derivatives you will hear about in the market – futures and options. Both futures and options defer the deal to a later date. The only difference is that the futures transaction forces the deal to happen at the later defined date, while the options transactions gives a choice to one of the parties to have the deal or call it off.

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