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Derivatives trading is traded using derivative contracts which derives its value from the underlying financial asset. This financial asset can be a stock, bond, commodity, forex currency pair, market index, interest pair, etc. The price movements of the financial asset are considered in the derivative contracts.
Contracts are made only on the elements such as the price movements of the financial asset and it is not required to own the financial asset. Sometimes the person holding the financial asset will also involve in Derivative trading to hedge the risks involved in holding that asset. Derivatives trading became popular with commodity trading where the buyers and sellers used to lock their future prices beforehand.
Derivatives trading is mostly preferred by traders as they cost less than normal trading and it is more feasible. This type of trading is popular in Over-The-Counter platforms.
Derivatives trading are broadly classified according to where the Derivatives trading takes place such as the Exchange-Traded Derivatives trading and Over-The-Counter Derivatives trading.
When the Derivatives trading takes place in regulated exchanges which are highly centralized with regulations it is called Exchange-Traded Derivatives trading. It does not have any counterparty risks as all the transactions are recorded and monitored by the clearing houses. Two main types of Derivative contracts that are traded in Exchanges are Futures and Options. Exchange-traded derivatives are available in all kinds of exchanges such as the Stock exchange, Commodity exchange, etc.
If you Buy a Derivative Contract it is called Call.
If you Sell a Derivative Contract, it is called Put.
The options traded in the exchanges are recorded and settled through Options Clearing Corporation which makes them more regulated and reduces the counterparty risks. Some examples of Exchange-Traded Options are Stock options, Index options and Bond options.
Forwards are same as the futures contract that happens in private trade dealings and Over-The-Counter trade. It has counterparty risks involved as they are traded bilaterally.
The Contract for difference is a contract made on financial derivatives in which the traders exchange the difference in asset price while opening or closing a trade.
A Contract for difference considers the price movements of the underlying financial asset. You buy a CFD when you guess or speculate that the price of the underlying asset will increase, and you sell it when you speculate that the price will go down. The price difference either gives you profit or loss. The difference in CFD is the difference in the price of the underlying asset in which you execute the trade.
The features of Contract for difference are,
Swaps are derivative contracts where the exchange of cash flows or liabilities or financial obligations take place between the two different financial institutions of the holders/parties of the contract. The best example for swaps would be the interest rate swaps.
Retail investors and traders do not generally engage in swaps and it is most prominent between companies, corporations, businesses, and financial institutions such as the banks. Swaps are well customized to fulfil the specific needs of these institutions.
Some other examples of swaps are currency swaps, commodities swaps, debt-equities swaps, total return swaps and credit default swaps.
These Derivatives trading types and their respective derivative contracts involved are major ones available in various Exchanges and Trading platforms. Many new forms of Derivatives trading are created day by day and getting popularity.
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